on micro enterprise development by ramon t. ayco

8/14/2019 On Micro Enterprise Development by Ramon T. Ayco

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On Micro-Enterprise page 1

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On Micro-Enterprisey Ramon T. AycoAugust 1, 2007

I. Introduction

The Project Development Institute (PDI),is a non-government organization (NGO)

working for genuine agrarian reform and

alternative rural development strategies

through participatory methods. Its vision is

the establishment of viable, sustainable and

self-reliant communities in partnership with

peoples organizations, other non-government

organizations and government agencies

undertaking genuine agrarian reform and rural

development.

Since the beginning, rural micro-enterprise

development is always a part of PDIs rural

development programs. Now it is exerting

every effort in developing and expanding

its established rural micro-enterprises. We

are making this research paper on micro-

enterprise development primarily as our guide.

We hope that this will also help others.

Poverty and unemployment

There is no doubt, poverty is one of the

biggest problem in the world today, and how

to solve this problem is one of the greatest

task facing everyone of us.

When estimating poverty worldwide, the

same reference poverty line has to be used,

and expressed in a common unit across

countries. Therefore, for the purpose of global

aggregation and comparison, the World Bank

uses reference lines set at $1 per day for the

poorest orvery poor people (or those in

the extreme economic poverty) and $2 per day

for the poor people who are living in the

upper half of those living below their nations

poverty line* (more precisely $1.08 and $2.15

in 1993 Purchasing Power Parity terms). It has

been estimated that in 2001, 1.1 billion people

had consumption levels below $1 a day and

2.7 billion lived on less than $2 a day.

* Microcredit Summit Campaign data

In the Philippines despite the fact that poverty

incidence had declined from 49.3 per cent in

1985 to 40 per cent in 2000, the number of

poor people has risen from 26.2 million to

31.3 million during the same period. Providing

employment for an increasing number of

job seekers is a reality which is difcult toconfront. ramatic population increase and

the deterioration of public education have

created a pool of unskilled workers who now

account for 29.3 percent of the total labor

force (National Statistics Ofce 2003; World

Bank Group 2001; Amante et al. 1999). Rural

poverty, aggravated by population growth,

has pushed rural folk to migrate to cities. But

the failure of the stagnant industrial sector

to absorb them has caused many workers toremain unemployed (dened as lacking a job

or business and not looking for work because

of a belief that no work is available, temporary

illness/disability, bad weather, or pending

job application/interview) or underemployed

(working less than 40 hours during the

reference period and wanting additional hours

of work). Around 30 percent of the labor force

in the Philippines has been consistently un- or

underemployed (National Statistics Ofce

2003).

In many cases many of the worlds poor

people cannot improve their own lives

because they have little access to the nancial

products and services that help those in the

developed world bridge the gap when times

are tough. Without life or health insurance,

diseases and illness go untreated and the death


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of an income earner is a dramatic hardship

for a family. Without access to loans or

credit, shop-owners cannot buy products in

bulk and farmers cannot buy machinery or

even seeds after a natural disaster or a poor

yield the season before. Without access to

savings accounts, money is hidden in walls or

oorboards where it can be stolen or lost in aood or re.

In many cases local money lenders are the

only available source of capital. They provide

loans to smooth incomes during rough times

or to help individuals improve their small

businesses, but they do so at exorbitant annual

interest rates, often from 300 percent to 3,000

percent. Under this system, virtually all of a

borrowers nancial gains are passed directlyto the money lender. Individuals are unable to

reap the rewards of their own hard work.

The policymakers and practitioners who

have been trying to improve the lives of the

poorest and poor people face an uphill battle.

Reports of bureaucratic sprawl and unchecked

corruption abound. And many now believe

that government assistance to the poor often

creates dependency and disincentives thatmake matters worse, not better. Moreover,

despite decades of aid, communities and

families appear to be increasingly fractured,

offering a fragile foundation on which to

build.

Micro-nance for micro-enterprise

Amid the dispiriting news, excitement is

building about a set of unusual nancial

institutions prospering in distant corners of

the world. The hope is that much poverty

can be alleviatedand that economic

and social structures can be transformed

fundamentallyby providing nancial

services to low-income households. These

institutions, united under the banner of

micronance for micro-enterprise, share a

commitment to serving clients that have been

excluded from the formal banking sector.

Almost all of the borrowers do so to nance

self-employment activities, and many start

by taking loans as small as $75, repaid over

several months or a year. Only a few programs

require borrowers to put up collateral,

enabling would-be entrepreneurs with few

assets to escape positions as poorly paid wagelaborers or farmers.

Some of the programs serve just a handful of

borrowers while others serve millions. In the

past two decades, a diverse assortment of new

programs has been set up in Africa, Asia, Latin

America, Canada, and roughly 300 U.S. sites

from New York to San Diego (The Economist

1997). Globally, there are now about 8 to 10

million households served by micronanceprograms, and some practitioners are pushing

to expand to 100 million poor households by

2005. As James Wolfensohn, the president of

the World Bank, has been quick to point out,

helping 100 million households means that as

many as 500600 million poor people could

benet.

The micro enterprise and small business

has always played a signicant role in theeconomic development of a Country. Its

role might not have been as spectacular as

that of the large corporation involving the

deployment of enormous physical, nancial

and human resources. However, the collective

impact of the multitude of micro enterprises

has been tremendous, particularly in the area

of job creation. The small business has been

a major source of jobs in the United States

(Birch, 1987). In Canada nearly 70% and, in

some regions almost 100% of new jobs are

attributed by small business (Tang and Kutryk,

1992).

In the Philippines: the Department of Trade

and Industry (DTI) estimates that small and

medium enterprises (SMEs) comprise over

90% of Philippine enterprises and are among

the principal drivers of economic growth and


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development. Micro, small and medium scale

enterprises (MSMSEs), on the other hand,

comprise about 70% of the countrys labor

force in both the formal and informal sectors.

II. Denition of micro-enterprise

The nature of entrepreneurship

Over the centuries, the notion of

entrepreneur and entrepreneurship has

been used in various senses. Conventionally,

entrepreneurship has been considered as an

inborn trait of the individual. In the Middle

Ages entrepreneur was a person who was

active and got things done. In the 16th

Century it describes those who risked theirlives and fortunes in Wars. In 17th and 18th

century it denotes those who risked their

wealth in a business enterprise or nancial

contracts (Gunning, 1992). Although the last

denition reects the notion of entrepreneur

and entrepreneurship, as we understand today,

it doesnt capture its characteristics. It does

not provide an answer to questions such as:

What does an entrepreneur do? What qualities

and attributes make an entrepreneur effective?This view of entrepreneurship has induced

academicians to focus on studies of business

communities.

The very notion of entrepreneur has

changed over time. The classical economists

considered the entrepreneur, essentially in

relation to risk and prot. The entrepreneur

uses the factors of production to obtain a prot

against the risk involved in the process.

John Stewart Mill calls him undertaker who

reaps the difference between interest and gross

prot as remuneration for his exertions and

risks.

Joseph Schumpeter stressed that the primary

importance of the entrepreneur lies in his

ability to introduce innovations. He has been

dened as any one in any type of society

who evolves a new technical, artistic, or social

programme and puts it into practices. So the

primary function of the entrepreneurs is to

do things in a new way, which Schumpeter

terms the creative response. To overcome

resistance and win the consumers is another

crucial function of the entrepreneur. Thecrucial function of setting up a new

production function makes the entrepreneur a

concept involving a center of usual qualities.

hat is a micro-enterprise?

Basically a icro-enterprise is smaller than

small and medium enterprises. It is a very

small (micro), informally organized business

(enterprise) undertaken by poor people. Eachmicro-enterprise is different, so the size, type

of business, and legal arrangements can vary a

great deal.

To differentiate micro-enterprises to small and

medium enterprises:

Those who promote mall enterprises

act out of an entrepreneurial logic that

demands know-how. Their activities areclearly dened and these bosses carry

them out fully with the help of their family

members and, above all, employees and

apprentices. These enterprises are often

registered (individual enterprises), pay taxes

and occasionally participate in professional

organisations. Technology remains relatively

simple but nevertheless requires investment,

light equipment, and permanent premises.

The promoters therefore need seed funds.

However, quantitative criteria are insufcient

to dene this category of units that have staffs

generally ranging from three to fty or so

people. This category can also include micro

enterprises and some medium enterprises.

A whole group of enterprises with growth

potential exists within this category and is

involved in a process of diversication and

modernisation.


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An entrepreneurial attitude (in the classic

sense of the word), a medium and long

term vision, and technical and managerial

capacities are indispensable for those who

promo e medium enterprises They have staff

with very specic functions, in specialised

and sometimes diversied activities. In

most cases, they exist legally. Technologicalcomplexity and mass production require

appropriate production means on specialised

sites. Equity capital and sometimes

considerable working capital are therefore

necessary. Their potential for accumulation

and growth is real.

Now, those who create micro enterprises use

simple technical skills and sometimes receive

help from family members or apprentices.The very small scale of their activities only

allows them to meet their needs. Their legal

status is often somewhat ambiguous but they

frequently pay taxes. Their activities require

simple technologies, small tools, and a small

amount of working capital to purchase raw

materials and renew small equipment. They

do not always require permanent premises.

Their evolution potential remains low; they

operate in a schema of reproduction ratherthan of growth. Horizontal diversication is

sometimes possible.

Micro enterprises embody an impressive

array of initiatives, skills and talents,

which if effective forms of assistance can

be developed, have the potential to make

an enormous contribution to the economic

growth. Micro enterprise is not just the latest

buzzword in development assistance.

Mari Nowak dene micro enterprise as an

entity employing less than ve persons,

generating income from non farm production,

service and trade. Hernando de Soto

classied micro enterprise as subgroup

of informal sector. Muhammad Yunus of

Bangaladesh nds little scope in describing

the character of micro enterprise rather

interested to see the whole objective of

assisting micro enterprise should be reduction

of poverty.

Mrs. Nancy David views micro enterprise

basically as a small undertaking run by

an individual who as proprietor takes up

responsibility of the managing the venture.Such micro enterprise may be subsistence

level rms in the informal sector somewhat

protable non-registered rms; registered

craft oriented small rms and registered

well-established rms, desirous of

expansion.

In the Philippines, REPUBLIC ACT NO.

8289 otherwise known as the MAGNA

CARTA FOR SMALL ENTERPRISES denemicro and small and medium enterprises as

follows:

Sec. 3. Small and Medium Enterprise as

Beneciaries. - Small and Medium Enterprise

shall be dened as any business activity or

enterprise engaged in industry, agribusiness

and/or services, whether single proprietorship,

cooperative, partnership or corporation whose

total assets, inclusive of those arising fromloans but exclusive of the land on which the

particular business entitys ofce, plant and

equipment are situated, must have value falling

under the following categories:

Micro less than 1,500,001

Small 1,500,001 15,000,000

Medium 15,000,001 60,000,000

The above denitions shall be subject to

review and adjustment by the said Council

moto proprio or upon recommendation of

sectoral organization(s) taking into account

ination and other economic indicators. The

Council may use as variables the number of

employees, equity capital and asset size.


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Characteristics of micro-enterprise

Micro-enterprises aim to make money, not

to give people something to do. They are not

concerned with getting a job for the sake of

having something to do. They may (probably

will, in fact) help people to have richer, more

purposeful lives, and provide new connectionswith their communities. But these are not

the main aim. Most people with learning

disabilities (and long-term members of other

disadvantage groups) have very little money

which is under their control. More money

brings new opportunities.

Micro-enterprises aim to make money

by seeking out ordinary commercial

opportunities. They make capitalismwork to the benet of people who have

been disadvantaged. They dont generate

income through donations or grants (except,

possibly, as start-up money) and almost

certainly dont depend on the social care

industry. Micro-enterprises, like other

ordinary businesses, aim to offer ordinary

citizens a product or service for which

theyll be willing to pay.

Micro-enterprises are built on an individual

basis. They are not schemes, projects, or

standard packages to be delivered to whole

groups of people. They require thinking at the

micro level - about this person, with these

interests, living in this community.

Micro-enterprises are usually owned by one

person, and are very unlikely to be shared

between more than three. If the micro-

enterprise has been created to match one

persons requirements, then its probably

only right for that person. And by keeping

the ownership to one person, theres the best

possible chance that the person will have

real control over it. There are times when

two people can make a success of sharing

ownership, but these are the exceptions - and

three people sharing is a risky option. For

example, what happens if one person want to

leave the business?

The cost of starting a micro-enterprise

doesnt need to be high. In the Philippines,

one can start a business with only P50 (almost

$1) as a starting capital provided that whatever

happens you dont spend the prots and addthese up to your capital until it became bigger

and bigger.

The amount of ncome can vary widely - and

it partly depends on what each person want to

achieve. Some people may be very happy if

their micro-enterprise makes just a little bit of

money - enough, for example, to save up over

a year and spend on a good summer holiday.

The US experience suggests micro-enterprisesoften create a higher level of income than

that, and just a few make tens of thousands of

pounds.

People with very high support needs can have

micro-enterprises. If a business is set up in the

right way, it can make an income with very

little effort in return.

Likewise, the amount of time they requirecan vary from a few days a year to a full-

time occupation. Theyre designed to suit

each person, and some people may want, for

example, to run their businesses at events

that only take place a few times a year. Some

kinds of micro-enterprise may run with very

little effort (from a business point of view,

an ideal arrangement!). All this means that

micro-enterprises cant be viewed as an option

that will necessarily provide an alternative

weekday occupation.

Informal economy

Most if not all micro-enterprises belongs to

the informal economy.

The informal economy is made up of those

individuals engaged in entrepreneurial


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endeavors who have no available knowledge

of entrepreneurial and lending services

and do not fully understand the long-run

importance of interfacing their businesses with

government agencies.

In the United States, the Aspen Institutes

FIELD project has conducted studies on thiseconomy to provide a better picture of who

makes up this sector and what the wants/needs

are for developing these entrepreneurs. The

following studies were completed in 2003:

The FIELD program describes the informal

economy as that component of the overall

market in which enterprises, employers and

self-employed individuals engage in legal

but unregulated activities. While they do notcomply with standard business practices,

taxation regulations and/or other business

reporting requirements, they are otherwise

not engaged in overtly criminal activity. It

includes both employed and self-employed

workers; cash is the most common medium

of exchange; and inferior work conditions are

commonplace for workers. Micro programs,

for the most part, are serving individuals in

this sector, but it is thought the market is muchlarger than the current reach.

For the most part, these individuals were not

aware of services available to businesses.

FIELD found that possibly a third of this

population would be candidates at any given

time for microenterprise services. This group

contained those who expressed ambition and

interest in growth, as well as those who would

cautiously consider it. FIELD concluded

that they would benet from sound business

analysis and guidance that is found in high-

quality microenterprise programs. It is

important that these services could be adapted

to the specic needs and time and place

constraints of the busy entrepreneurs.

In addition, the study found that there is a role

for micro programs to assist communities in

appreciating and supporting entrepreneurs in

their area and in helping informal economy

entrepreneurs look at their own work from

a business perspective. The study also

found a need for fully funding structures

and incentives in the state so that more

entrepreneurs can be reached.

Meanwhile in the Philippines, the ofcial

denition (2) adopted by the National Census

and Statistical Board on November 6, 2002

characterizes the informal segment of the

Philippine economy as:

Units engaged in the production of goods

and services with the primary objective of

generating employment and incomes to the

persons concerned. It consists of householdunincorporated enterprises that are market

and non-market producers of goods as well as

market producers of services.

These enterprises are operated by own account

workers, which may employ unpaid family

workers as well as occasional, seasonally

hired workers.

These enterprises may also be owned and

operated by employers, which may employless than 10 employees on a continuous basis.

Excluded are corporations, quasicorporations,

units with 10 or more employees, corporate

farms, commercial livestock raising and

commercial shing. (NSCB 2002).

As an economic and social group, the informal

sector is composed of a variety of people with

different types of work homeworkers, micro-

entrepreneurs, street vendors and peddlers,

drivers and operators of taxicabs, jeepneys,

tricycles and other public conveyances,

petty retailers, barter traders, small-scale

construction workers, small-miners, small

farmers and sherfolks.

As elsewhere in Asia, the informal sector

in the Philippines is rapidly expanding as a

consequence of worsening unemployment


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due to retrenchment of industries; declining

agricultural production; falling real wages

due to ination; and the widening income

inequality and poverty where women,

men and children are struggling to earn their

living through extra legal means in order to

survive. In contrast to formal wage workers,

the informal workers have grown throughoutthe decades and have consistently remained a

stubborn feature of the Philippine economy,

so much so that their activities have gained

acceptance as a survival strategy of the poor.

There are an estimated 22.5 million Filipinos

belonging to the informal sector, which

represents 75 percent of the total work force,

according to the Department of Labor and

Employment (DOLE).

Many of the countrys informal sector

specically in the cities are severely resource-

constrained small vendors operating not only

in public markets but also in the sidewalks

and streets. Their survival in business relies

heavily on access to nancing. This usually

comes from the informal sector as well in

the form of informal nanciers called 5-6.

Two types of 5-6 nanciers are found in thePhilippine, each with a distinctive lending

mechanism, Filipinos and Indian nationals

popularly known as Bombay.

Five-six (5-6) moneylenders charge a

nominal interest rate of 20 percent over

an agreed period of time. A person who

borrows 5 pesos from a 5-6 moneylender

over a period of one week repays 6

pesos, including 1 peso interest. Neither

Filipino nor Indian 5-6 moneylenders

require collateral or documents from their

borrowers. The success of a borrowers

business and loan repayment history

provide a gauge of the borrowers

credibility.

As data shows informal sectors comprised

the bulk of the labor force in the Philippines

and contributing much to the economy of

the country. With this it is important for the

government to adopt a more active role in

providing them with the assistance they need

to cope with the difculties of economic

shifts. In this regard, a number of Philippine

laws and policies have been promulgated that

either directly or indirectly seek to increasethe informal sectors access to productive

resources, improve their working conditions

and welfare, and extend social protection.

Some of these were the result of long years

of advocacy on the part of informal workers

groups.

To date, enacted laws and policies that

are congenial to the informal sector are:

Agriculture and Fisheries ModernizationAct (RA 8435), the Magna Carta for Small

Enterprises (RA 6977), the Cooperative

Code of the Philippines (RA 6938), the

Cooperatives Development Authority

(CDA) Law (RA 6939) and the Social

Reform and Poverty Alleviation Act (RA

8425 of 1998) which provides an entire

section on micronance services for the

poor. Additionally, with the passage of

Executive Order 452, registered vendorsare encouraged to form an association for

empowerment. This law may in the long run

prove benecial to women since majority

of them earn income as vendors. Under this

promulgation, the LGUs are mandated to

address vendors security at the workplace

by providing vending sites around the

municipal hall.

Moreover, under the Social Development

Council of NEDA (National Economic and

Development Authority), a Country Program

for Institutionalizing Programs and Projects

for the Informal Sector through the Local

Governments was approved in 2003 with

DOLE initiating its implementation (or

roll-out) containing strategies pertaining to

recognition, social protection and access to

productive resources.


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On the other hand, some pertinent laws

and policies that have been passed need

further improvement and enforcement,

most especially those with clear-cut gender

perspective, such as the Act for Women

in Micro and Cottage Business Enterprise

(RA 7882), Act Promoting the Integration

of Women as Full and Equal Partners ofMen in Development and Nation Building

(RA 7192) and the Implementing Rules on

the Employment of Homeworkers (DOLE

Department Order No 5).

III. Women in Micro-EnterpriseDevelopment

Of the estimated 1.3 billion people in theworld living in poverty, more than 70%

are female (UNDP 1995: 36). The number

of women living in poverty has increased

disproportionately over the past decade

compared with the number of men (Platform

For Action 1995: para 48). The feminisation

of poverty is a direct consequence of womens

unequal access to economic opportunities.

In recent years, micro-nancing for womenssmall and micro-scale enterprises has been

seen as an effective way to promote and

support womens self-employment and

access to credit. The promotion, nancing

and strengthening of micro-enterprises was

also highlighted in the Beijing Platform For

Action as an important way of increasing the

productive capacity of women, and breaking

the cycle of poverty (Platform For Action

1995: paras 55, 166).

omen in local economies

Women entrepreneurs play an important role

in local economies, and a large percentage of

micro-enterprises in developing countries are

undertaken by women. Increasingly women

in urban and rural areas are successfully

turning to self-generated employment in

small-scale enterprise activities in the informal

sector to support their households.

Women have proven to be the best poverty

ghters. Experience and studies have shown

that they use the prots from their businesses

to send their children to school, improve theirfamilies living conditions and nutrition, and

expand their businesses. As families cross the

poverty line and micro-enterprises expand,

their communities benet. Jobs are created,

knowledge is shared, civic participation

increases, and women are recognized as

valuable members of their families and

communities.

The rationale behind women becomingeconomic actors has been examined by

various researchers. Income generating

activities are not merely viewed as a tool

for economic needs of women. It is equally

a powerful instrument to enable women to

determine their own lives (Bennet, 1992).

Women are culturally well equipped to run

their business due to skill developed through

managing households, raising children etc.

Therefore, shift from family managementto enterprise management (Harper and

Vyakarnam, 1988) may be easier than a shift

from paid employment to self-employment. .

istorical background

The focus on the contribution of women

in direct productive work was rst brought

out in 1970 by Ester Boserup in her book

Womens Role in Economic Development.

This work of Boserup is a compilation of her

research experience in India. It also provided a

conceptual framework for research on Women

in Development. Around the mid 1970s, neo-

Marxist feminists and dependency theorists

began looking at the relationship between

women and development rather than the

strategies for integrating women in economic

development. However, lack of understanding


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of womens work in developing societies,

and Western biases in development projects

reinforced the division between public and

private spheres of women lives (Ghosh R).

Women and development (WAD) like women

in development (WID) focused on productive

sector, and aimed at skill development for

income generation.

In 1980s, the gender and development approach

(GAD), inuenced by social feminism, post

modern and post colonial theories, took into

account the totality of womens lives, rejecting

the public / private dichotomy which serves

to devalue womens work at home. Focus on

women perspectives on development makes

women the subjects rather than objects

of development, change agents rather thanwelfare recipients. The GAD approach is to

move women from the margin to the center

(Hooks, 1984) by women getting a sense of

control over their lives. Entrepreneurship

activities for women are clearly within the

GAD framework. Development cannot be

sustained unless people for whom it is intended

are at the center of development activities. The

goal of development is not merely to initiate

a process of economic growth, but also aprocess, which will improve the lives of the

people. The concept of empowerment through

enterprise is underlined through this thinking.

Micro enterprise represents an important means

of earning income for women in developing

countries.

It is not easy for women to nd out a job that

will be suitable with their family responsibility

and household work. Thus many women

are attracted by the idea of self-employment

in micro enterprises adjoining their house

premises with exible hours, which allow

them to take care of both home and business.

It provides employment and income to

alleviate poverty.

The difference between income generation and

entrepreneurship is in the conscious decision

regarding opportunity costs involved in

entrepreneurship development as opposed to

generate causal income (Kraus- Harper, 1992)

Micro enterprises are small undertakings

run by individuals or groups who take up

responsibility of managing a business venture

and often involved in the family activities. The

micro enterprises suit the life style of womenbecause of their multiple roles and need to re-

organise time. Originally micro enterprises for

women were extension of kitchen activities.

Now women have ventured into engineering,

electronics and other industries (David,

1992).

Hindrances

But there are hindrances that needs tobe overcome in order for women to fully

participate in economic development through

micro-enterprises.

Rural women frequently have primary

responsibility for agricultural production,

in addition to domestic responsibilities and

childcare. These responsibilities place heavy

demands on womens time, and micro-

enterprise activities can potentially increasethe workload of women. Improving access

to labour-saving technologies in any of these

areas can free up time for income generating

micro-enterprise activities.

Limited access to productive resources

(particularly capital, labour time and

technologies), transport constraints, lack of

market knowledge, and lack of basic literacy

and numeracy skills can restrict the capacity

of women to participate effectively in business

activities.

Women, who generally do not have ownership

of land or capital goods, can be disadvantaged

by the collateral-based lending policies

of nancial institutions. For example,

UNDP estimates that only 5% of the credit

provided by multilateral banks reaches rural


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women (UNDP 1995: 39). In some places,

government and/or institutional regulations

require that women seeking bank loans secure

their spouses signature.

Social attitudes concerning the value of

traditional womens work activities and their

potential abilities can limit the participationrates and ultimate commercial success of

female micro-entrepreneurs. In the past,

income-generation projects for women have

frequently been for marginal activities with

limited marketing potential and poor return

for labour. They have often been based on

the implicit assumption that womens income

is supplementary to that of the male head of

household. Loans for men are usually larger

and more long-term than those provided forwomen. However, much evidence indicates

that women are very good credit risks, with

many small-scale credit projects for women

reporting very high repayment rates in a range

of sectors and activities.

Development organisations such as co-

operatives, which restrict membership to

one household member, may also exclude

women from access to resources such ascredit. There is often the risk that in womens

micro-enterprise schemes, the benets of the

activities, including income earned and assets

accrued, will not necessarily be controlled

by women for expenditure on their own and

basic family needs. Training and support is

needed for micro-enterprise projects, in both

the micro-nancing (management of savings

and credit) and micro-enterprise development

(small business and technical training) areas.

According to the International Fund for

Agricultural Development (IFAD), there

are four key criteria for micro-enterprise

development schemes aimed at poor rural

women, which can both improve demand for

credit and reduce the risks of indebtedness.

These are: modest nancial investment,

low investment risk, short gestation period

between investment and generation of regular

income, and availability of local markets

(IFAD 1991: 9).

IV. Micro-Finance forMicro-Enterprise

The need for micronance

Studies in India, Kenya and the Philippines

found that the average annual return on

investments by micro-enterprise ranged from

117 to 847 per cent. If they are so lucrative,

why didnt these businesses start sooner? Lack

of capital. Poor people either have no money

to get started, or have to borrow from loan

sharks who charge usurious rates that wipe out

prots.

What is really needed here is micronance.

Micronance is the supply of banking

services to micro-enterprises and poor

families. It helps people to escape poverty

by giving them collateral-free loans and

other nancial services to support income-

generating businesses. A key to micronance

is the recycling of loan dollars. As each loanis repaidusually within six months to a

yearthe money is recycled as another loan,

thus multiplying the value of each dollar in

defeating global poverty, and changing lives

and communities.

Micronace is not only Microcredit. The latter

refers specically to loans and the credit needs

of clients, while micronance covers a broader

range of nancial services that create a wider

range of opportunities for success. Examples

of these additional nancial services include

savings, insurance, housing loans and remittance

transfers. The local micro-nance institution

might also offer micronance plus activities such

as entrepreneurial and life skills training, and

advice on topics such as health and nutrition,

sanitation, improving living conditions, and the

importance of educating children.


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Sometimes called banking for the poor,

micronance is an amazingly simple approach

that has been proven to empower very poor

people around the world to pull themselves

out of poverty. It is sustainable and can be

implemented on the massive scale necessary

to respond to the urgent needs of those

living on less than $1 a day. Relying on theirtraditional skills and entrepreneurial instincts,

very poor people, mostly women, use small

loans, other nancial services, and support

from local organizations called micronance

institutions (MFIs) to start, establish, sustain,

or expand very small, self-supporting

businesses.

From ancient slums and impoverished villages

in the developing world to the tired inner citiesand frayed suburbs of Americas economic

fringes, millions of people, mostly women, are

all part of a revolution. Some might call it a

capitalist revolution . As little as $25 or $50 in

the developing world, perhaps $500 or $5000

in the United States, these microloans make

huge differences in peoples lives. Many Third

World bankers are nding that lending to the

poor is not just a good thing to do but is also

protable. (Brill 1999)

Advocates who lean left highlight the

bottom-up aspects, attention to community,

focus on women, and, most importantly,

the aim to help the under-served. It is no

coincidence that the rise of micronance

parallels the rise of nongovernmental

organizations (NGOs) in policy circles and

the newfound attention to social capital

by academics (e.g., Robert Putnam 1993).

Those who lean right highlight the prospect of

alleviating poverty while providing incentives

to work, the nongovernmental leadership,

the use of mechanisms disciplined by market

forces, and the general suspicion of ongoing

subsidization.

There are good reasons for excitement about

the promise of micronance, especially

given the political context, but there are

also good reasons for caution. Alleviating

poverty through banking is an old idea with

a checkered past. Poverty alleviation through

the provision of subsidized credit was a

centerpiece of many countries development

strategies from the early 1950s through the

1980s, but these experiences were nearly alldisasters. Loan repayment rates often dropped

well below 50 percent; costs of subsidies

ballooned; and much credit was diverted to the

politically powerful, away from the intended

recipients (Dale Adams, Douglas Graham, and

J. D. von Pischke 1984).

What is new? Although very few programs

require collateral, the major new programs

report loan repayment rates that are in almostall cases above 95 percent. The programs have

also proven able to reach poor individuals,

particularly women, that have been difcult

to reach through alternative approaches.

Nowhere is this more striking than in

Bangladesh, a predominantly Muslim country

traditionally viewed as culturally conservative

and male-dominated. The programs there

together serve close to ve million borrowers,

the vast majority of whom are women, and,in addition to providing loans, some of the

programs also offer education on health

issues, gender roles, and legal rights. The

new programs also break from the past by

eschewing heavy government involvement

and by paying close attention to the incentives

that drive efcient performance.

The micronance revolution, begun with

independent initiatives in Latin America

and South Asia starting in the 1970s, has so

far allowed 65 million poor people around

the world to receive small loans without

collateral, build up assets, and buy insurance.

The UN Year of Microcredit in 2005

and the Nobel Peace Prize Mohammed

Yunus and Grameen Bank in 2006 have

given considerable public recognition to


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micronance as a development tool. Christen

et al. (2004) reports an astonishing 500 million

persons served, mostly with savings accounts,

while the Microcredit Summit in their 2006-

meeting in Halifax celebrated the milestone

of 100 million borrowers. Nevertheless,

micronance still only reaches a fraction

of the worlds poor (Christen et al., 2004,Robinson, 2001). Hence, there is a recognized

supply challenge in the market (Helms, 2006).

Key Principles of Micronance

These principles were developed and

endorsed by the Consultative Group to

Assist the Poor(CGAP) and its 31 member

donors, and further endorsed by the Group of

Eight leaders at the G8 Summit on 10 June2004. CGAP is a consortium of 31 public

and private development agencies working

together to expand access to nancial services

for the poor, referred to as micronance.

1. oor people need a variety of nancial

services, not just loans. Like everyone

else, the poor need a range of nancial

services that are convenient, exible, and

affordable. Depending on circumstances,they want not only loans, but also savings,

insurance, and cash transfer services.

2. Micronance is a powerful tool to ght

poverty. When poor people have access

to nancial services, they can earn more,

build their assets, and cushion themselves

against external shocks. Poor households

use micronance to move from everyday

survival to planning for the future: they

invest in better nutrition, housing, health,

and education.

3. Micronance means building nancial

systems that serve the poor In most

developing countries, poor people are

the majority of the population, yet they

are the least likely to be served by banks.

Micronance is often seen as a marginal

sectora development activity that

donors, governments, or social investors

might care about, but not as part of the

countrys mainstream nancial system.

owever, micronance will reach the

maximum number of poor clients only

when it is integrated into the nancial

sec or.

4. icronance can pay for itself, and must

do so if it is to reach very large numbers

of poor people. Most poor people cannot

get good nancial services that meet their

needs because there are not enough strong

institutions that provide such services.

Strong institutions need to charge enough

to cover their costs. Cost recovery is not an

end in itself. Rather, it is the only way toreach scale and impact beyond the limited

levels that donors can fund. A nancially

sustainable institution can continue and

expand its services over the long term.

Achieving sustainability means lowering

transaction costs, offering services that are

more useful to the clients, and nding new

ways to reach more of the unbanked poor.

5. icronance is about buildingermanent local nancial institutions.

inance for the poor requires sound

domestic nancial institutions that provide

services on a permanent basis. These

institutions need to attract domestic

savings, recycle those savings into loans,

and provide other services. As local

institutions and capital markets mature,

there will be less dependence on funding

from donors and governments, including

government development banks.

6. icrocredit is not always the answer.

icrocredit is not the best tool for

everyone or every situation. Destitute

and hungry people with no income or

means of repayment need other kinds of

support before they can make good use

of loans. In many cases, other tools will


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alleviate poverty betterfor instance,

small grants, employment and training

programs, or infrastructure improvements.

Where possible, such services should be

coupled with building savings.

7. nterest rate ceilings hurt poor people

y making it harder for them to getcredit. It costs much more to make many

small loans than a few large loans. Unless

microlenders can charge interest rates

that are well above average bank loan

rates, they cannot cover their costs. Their

growth will be limited by the scarce and

uncertain supply soft money from donors

or governments. When governments

regulate interest rates, they usually set

them at levels so low that microcreditcannot cover its costs, so such regulation

should be avoided. At the same time, a

microlender should not use high interest

rates to make borrowers cover the cost of

its own inefciency.

8. he role of government is to enable

nancial services, not to provide them

directly. National governments should

set policies that stimulate nancialservices for poor people at the same time

as protecting deposits. Governments

need to maintain macroeconomic

stability, avoid interest rate caps, and

refrain from distorting markets with

subsidized, high-default loan programs

that cannot be sustained. They should

also clamp down on corruption and

improve the environment for micro-

businesses, including access to markets

and infrastructure. In special cases where

other funds are unavailable, government

funding may be warranted for sound and

independent micronance institutions.

9. Donor funds should complement

rivate capital, not compete with it

onors provide grants, loans, and equity

for micronance. Such support should

be temporary. It should be used to build

he capacity of micronance providers;

o develop supporting infrastructure like

rating agencies, credit bureaus, and audit

capacity; and to support experimentation.

n some cases, serving sparse or difcult-

o-reach populations can require longer-

erm donor support. Donors should try tointegrate micronance with the rest of the

nancial system. They should use experts

with a track record of success when

designing and implementing projects.

hey should set clear performance

argets that must be met before funding

is continued. Every project should have a

realistic plan for reaching a point where

he donors support is no longer needed.

10. he key bottleneck is the shortage

of strong institutions and managers

icronance is a specialized eld that

combines banking with social goals.

Skills and systems need to be built at all

levels: managers and information systems

of micronance institutions, central

banks that regulate micronance, other

government agencies, and donors. Public

and private investments in micronanceshould focus on building this capacity, not

just moving money.

11. icronance works best when

it measuresand disclosesits

erformance. Accurate, standardized

performance information is imperative,

both nancial information (e.g., interest

rates, loan repayment, and cost recovery)

and social information (e.g., number of

clients reached and their poverty level).

onors, investors, banking supervisors,

and customers need this information to

judge their cost, risk, and return.

Micronance Institutions (MFIs)

Private suppliers of micronance are normally

incorporated as member based Cooperatives


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(COOP), Non Prot Organizations (NPOs) or

Shareholder Firms (SHFs). They are called

Micronance Institutions or MFIs.

MFIs are dedicated to alleviating poverty.

These frontline organizations reach out to

the very poor and delivermicronance

ervices to local clients daily. They educatelocal communities about the opportunity

to improve their lives with micronance;

make microloans and provide other nancial

services such as savings accounts, micro-

insurance and money transfers; collect

weekly loan payments; and assist clients in

solving some of the life challenges they may

face. Many are also integrating other social

empowerment strategies into their operations,

including healthcare and nutrition, nancialliteracy, and environmentally-friendly

technologies, such as solar energy and biogas.

Such strenuous programs and innovations

require constant growth in skills and capacity.

MFIs differ in size and reach: some serve a

few thousand clients in their immediate area,

while others serve hundreds of thousands

of very poor people through hundreds of

branches covering large regions.

MFIs that operate as non-prot foundations

traditionally btain their funds from donors,

retained earnings and, in some cases, from

public nancial institutions. With an estimated

expenditure rate of at least US $ 500 million

per year, development agencies remain the

most important external source of funding for

MFIs.

Grameen Bank for example provides funding

for MFIs through direct loans, grants, loan

guarantees and other innovative nancing

techniques. Other funding comes from

individuals, philanthropists, foundations, and

governments and international institutions

such as the World Bank. MFIs also borrow

funds from traditional banks to loan to

their clients. Some of the more successful

nonprots have managed to obtain funding

from commercial banks and more and more

commercial funding is being channeled to

micronance.

Unlike other loan programs, micronance

clients are not required to provide ollateral o

receive loans. This allows people who wouldnot qualify for loans at traditional nancial

institutions to receive credit. MFIs are also

very client-friendly; most usually go to their

clients to provide loans and receive payments,

rather than requiring their clients to come to

them. A few of them also use focal centers

where clients gather to conduct nancial

transactions and receive other social services.

Micronance clients are excellent credit risks.In Grameen Banks experience, for example,

the repayment rate is between 95 and 98

percent. In fact, it is higher than the repayment

rate of student loans and credit card debts in

the United States. They value the opportunity

to improve their lives.

Like other nancial institutions,

micronance institutions (MFIs) charge

interestfor the loans they make to theirclients. The interest collected goes back

into the program wherein part of it are

used to fund more loans and other part are

used to cover the high cost of making very

small loans and personally servicing each

client every week. It also covers the cost

of managing the center meetings; the

peer support group process; and providing

information on social services, personal

development, health and other critical

information that helps clients improve their

lives and the future of their families. Their

rates are also largely inuenced by the rates

MFIs themselves pay for borrowing the

funds that they in turn lend to their clients.

MFI interest rates can range from 18 to 60

percent, depending on the conditions in each

MFIs service area. Without micronance

programs, the most common alternative


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for very poor people is the local money

lenders, who regularly charge between 120

and 300 percent.

It is important to note that in many countries

the micronance industry is becoming a

competitive industry, leading MFI to lower

their interest rates, therefore improving thecost of services for micro enterprises.

One of the most attractive features of

micronance is thegoal of self-sufciency

for both microentrepreneurs and MFIs. No

institution can survive without reaching

nancial stability within a reasonable

period. Micronance Institutions must be

built to survive without subsidies. From a

nancial point of view, numerous experienceshave shown that it is possible to create a

self-sustainable micronance institution.

In Eastern Europe , IMI (Internationale

Micro Investitionen Aktiengesellschaft),

an investment company has invested in

other 26 MFIs so far, many of them already

reaching self-sufciency in Georgia, Bosnia &

Herzegovina, Albania, Ukraine etc. In Mexico,

Compartamos, one of the leading MFIs in

Latin America is fully self sufcient, etc, etc.Many examples prove us that Micronance

can be run as a self-sustainable operation.

Another example is the Grameen Foundation.

It is spearheading several initiatives to give

MFIs access to the private market nancing

options available to traditional banks. By

combining access to private market nancing

with more efcient management and

technology, MFIs can begin to move from

reliance on philanthropy to self-sufciency.

Grameen Bank in Bangladesh has proven that

this can be accomplished. It is totally self-

supporting and accepts no grants or donations.

The nancial viability of micronance

organizations, depends on: 1) sufcient

volume of activity; 2) a satisfactory spread

between the interest on loans and the cost

of funds; 3) the control of operating costs;

4) the control of outstanding payments and

misappropriations risks (involving procedures

for loan loss); 5) prot (to build reserves for

hard times ahead, and more importantly, with

which to expand the number of clients served

and range of services offered.)

Micronance Institutions (MFIs) have

accelerated economic transformations by

encouraging banks to signicantly expand

the micro-enterprises access to micronance

services. In the Philippines, for instance, the

Micro-enterprise Access to Banking Services

(MABS) program, assists clients rural banks

to increase the nancial services they provide

to the micro enterprise sector by providing

micronance technical assistance and trainingto rural banks. Trained banks in turn offer

micronance loan and deposit services

specially tailored to micro enterprise clients.

Today, it is estimated that 500 Million people

all over the world need access to nancial

services to develop income generating

activities. In our opinion, donor money will

not be enough

to reach this market, banks and nancialmarkets should help build nancial systems

all over the developing world that serve the

majority.

Micronance schemes

There are many micronance schemes

practiced and developed by different groups

of people and institutions all over the world.

Some schemes have specic unique features

totally different from the others, but most of

the schemes have almost the same features.

The best examples are the following:

a. he Grameen Bank, Bangladesh

The idea for the Grameen Bank did not

come down from the academy, nor from

ideas that started in high-income countries


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and then spread broadly.1 As the founder

Dr. Muhammad Yunus (1995) describes the

beginning:

Bangladesh had a terrible famine in 1974.

I was teaching economics in a Bangladesh

university at that time. You can guess how

difcult it is to teach the elegant theories ofeconomics when people are dying of hunger

all around you. Those theories appeared like

cruel jokes. I became a drop-out from formal

economics. I wanted to learn economics

from the poor in the village next door to the

university campus.

Yunus found that most villagers were unable

to obtain credit at reasonable rates, so he

began by lending them money from his ownpocket, allowing the villagers to buy materials

for projects like weaving bamboo stools

and making pots (New York Times 1997).

Ten years later, Yunus had set up the bank,

drawing on lessons from informal nancial

institutions to lend exclusively to groups

of poor households. Common loan uses

include rice processing, livestock raising, and

traditional crafts.

The groups form voluntarily, and, while

loans are made to individuals, all in the group

are held responsible for loan repayment.

The groups consist of ve borrowers each,

with lending rst to two, then to the next

two, and then to the fth. These groups of

ve meet together weekly with seven other

groups, so that bank staff meet with forty

clients at a time. According to the rules, if

one member ever defaults, all in the group

are denied subsequent loans. The contracts

take advantage of local information and the

social assets that are at the heart of local

enforcement mechanisms. Those mechanisms

rely on informal insurance relationships

and threats, ranging from social isolation to

physical retribution, that facilitate borrowing

for households lacking collateral (Besley and

Coate 1995). The programs thus combine

the scale advantages of a standard bank

with mechanisms long used in traditional,

group-based modes of informal nance, such

as rotating savings and credit associations

(Besley, Coate, and Glenn Loury 1993).

The Grameen Bank now has over two million

borrowers, 95 percent of whom are women,receiving loans that total $3040 million

per month. Reported recent repayment rates

average 9798 percent, but relevant rates

average about 92 percent and have been

substantially lower in recent years.

Most loans are for one year with a nominal

interest rate of 20 percent (roughly a 1516

percent real rate). Calculations suggest,

however, that Grameen would have had tocharge a nominal rate of around 32 percent in

order to become fully nancially sustainable

(holding the current cost structure constant).

The management argues that such an increase

would undermine the banks social mission

(Shahidur Khandker 1998), but there is little

solid evidence that speaks to the issue.

Grameen gures prominently as an early

innovator in micronance and has beenparticularly well studied. Programs that have

been set up in North Carolina, New York

City, Chicago, Boston, and Washington,

D.C. cite Grameen as an inspiration. In

addition, Grameens group lending model

has been replicated in Bolivia, Chile, China,

Ethiopia, Honduras, India, Malaysia, Mali, the

Philippines, Sri Lanka, Tanzania, Thailand, the

U.S., and Vietnam. When Bill Clinton was still

governor, it was Muhammad Yunus, founder

of the Grameen Bank (and a Vanderbilt-trained

economist), who was called on to help set up

the Good Faith Fund in Arkansas, one of the

early micronance organizations in the U.S.

b. ancoSol, Bolivia

Banco Solidario (BancoSol) of urban Bolivia

also lends to groups but differs in many


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ways from Grameen. First, its focus is

sharply on banking, not on social service.

Second, loans are made to all group members

simultaneously, and the solidarity groups

can be formed of three to seven members. The

bank, though, is constantly evolving, and it

has started lending to individuals as well. By

the end of 1998, 92 percent of the portfoliowas in loans made to solidarity groups and 98

percent of clients were in solidarity groups,

but it is likely that those ratios will fall over

time. By the end of 1998, 28 percent of the

portfolio had some kind of guarantee beyond

just a solidarity group.

Third, interest rates are relatively high. While

1998 ination was below 5 percent, loans

denominated in bolivianos were made at anannual base rate of 48 percent, plus a 2.5

percent commission charged up front. Clients

with solid performance records are offered

loans at 45 percent per year, but this is still

steep relative to Grameen (but not relative to

the typical moneylender, who may charge as

much as 10 percent per month). About 7080

percent of loans are denominated in dollars,

however, and these loans cost clients 2430

percent per year, with a 1 percent fee up front.

Fourth, as a result of these rates, the bank does

not rely on subsidies, making a respectable

return on lending. BancoSol reports returns on

equity of nearly 30 percent at the end of 1998

and returns on assets of about 4.5 percent,

gures that are impressive relative to Wall

Street investmentsalthough adjustments for

risk will alter the picture. Fifth, repayment

schedules are exible, allowing some

borrowers to make weekly repayments and

others to do so only monthly. Sixth, loan

durations are also exible. At the end of 1998,

about 10 percent had durations between one

and four months, 24 percent had durations

of four to seven months, 23 percent had

durations of seven to ten months, 19 percent

had durations of ten to thirteen months, and

the balance stretched toward two years.

Seventh, borrowers are better off than in

Bangladesh and loans are larger, with average

loan balances exceeding $900, roughly nine

times larger than for Grameen (although

rst loans may start as low as $100). Thus

while BancoSol serves poor clients, a recent

study nds that typical clients are among the

richest of the poor and are clustered justabove the poverty line (where poverty is based

on access to a set of basic needs like shelter

and education; Sergio Navajas et al. 1998).

Partly this may be due to the maturation

of clients from poor borrowers into less poor

borrowers, but the prole of clients also looks

very different from that of the mature clients

of typical South Asian programs.

The stress on the nancial side has madeBancoSol one of the key forces in the Bolivian

banking system. The institution started as an

NGO (PRODEM) in 1987, became a bank in

1992, and, by the end of 1998, served 81,503

low-income clients. That scale gives it about

40 percent of borrowers in the entire Bolivian

banking system.

Part of the success is due to impressive

repayment performance, although difcultiesare beginning to emerge. Unlike most other

micronance institutions, BancoSol reports

overdues using conservative standards: if a

loan repayment is overdue for one day, the

entire unpaid balance is considered at risk

(even when the planned payment was only

scheduled to be a partial repayment). By these

standards, 2.03 percent of the portfolio was at

risk at the end of 1997.

But by the end of 1998, the fraction increased

to 4.89 percent, a trend that parallels a general

weakening throughout the Bolivian banking

system and which may signal the negative

effects of increasing competition. BancoSols

successes have spawned competition from

NGOs, new nonbank nancial institutions, and

even formal banks with new loan windows

for low-income clients. The effect has been


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a rapid increase in credit supply, and a

weakening of repayment incentives that may

foreshadow problems to come elsewhere.

Still, BancoSol stands as a nancial success,

and the model has been replicated

protablyby nine of the eighteen other

Latin American afliates of ACCIONInternational, an NGO based in Somerville,

Massachusetts. ACCION also serves over

one thousand clients in the U.S., spread over

the six programs. Average loan sizes range

from $1366 in New Mexico to $3883 in

Chicago, and overall nearly 40 percent of

the clients are female. As of December 1996,

payments past due by at least thirty days

averaged 15.5 percent but ranged as high as

21.2 percent in New York and 32.3 percentin New Mexico. ACCIONs other afliates,

including six in the United States, have not,

however, achieved nancial sustainability.

The largest impediments for U.S. programs

appear to be a mixed record of repayment,

and usury laws that prevent micronance

institutions from charging interest rates that

cover costs (Pham 1996).

c. Rakyat Indonesia

Like BancoSol, the Bank Rakyat Indonesia

unit desa system is nancially self-sufcient

and also lends to better off poor and

nonpoor households, with average loan sizes

of $1007 during 1996. Unlike BancoSol and

Grameen, however, BRI does not use a group

lending mechanism. And, unlike nearly all

other programs, the bank requires individual

borrowers to put up collateral, so the very

poorest borrowers are excluded, but operations

remain small-scale and collateral is often

dened loosely, allowing staff some discretion

to increase loan size for reliable borrowers

who may not be able to fully back loans with

assets. Even in the wake of the recent nancial

crisis in Indonesia, repayment rates for BRI

were 97.8 percent in March 1998 (Paul

McGuire 1998).

The bank has centered on achieving cost

reductions by setting up a network of

branches and posts (with an average of ve

staff members each) and now serves about 2

million borrowers and 16 million depositors.

Loan ofcers get to know clients over time,

starting borrowers off with small loans and

increasing loan size conditional on repaymentperformance. Annualized interest rates are 34

percent in general and 24 percent if loans are

paid with no delay (roughly 25 percent and

15 percent in real terms before the recent

nancial crisis).

Like BancoSol, BRI also does not see

itself as a social service organization, and

it does not provide clients with training or

guidanceit aims to earn a prot and seesmicronance as good business (Marguerite

Robinson 1992). Indeed, in 1995, the unit

desa program of the Bank Rakyat Indonesia

earned $175 million in prots on their loans

to low-income households. More striking, the

programs repayment ratesand protson

loans to poor households have exceeded

the performance of loans made to corporate

clients by other parts of the bank. A recent

calculation suggests that if the BRI unit desaprogram did not have to cross-subsidize the

rest of the bank, they could have broken even

in 1995 while charging a nominal interest rate

of just 17.5 percent per year on loans (around

a 7 percent real rate; Jacob Yaron, McDonald

Benjamin, and Stephanie Charitonenko 1998).

d. redit Desa, Indonesia

The Bank Kredit Desa system (BKDs) in rural

Indonesia, a sister institution to BRI, is much

less well-known. The program dates back to

1929, although much of the capital was wiped

out by the hyper-ination of the middle 1960s

(Don Johnston 1996). Like BRI, loans are made

to individuals and the operation is nancially

viable. At the end of 1994, the BKDs generated

prots of $4.73 million on $30 million of net

loans outstanding to 765,586 borrowers.5


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Like Grameen-style programs, the BKDs lend

to the poorest households, and scale is small,

with an emphasis on petty traders and an

average loan size of $71 in 1994. The term of

loans is generally 1012 weeks with weekly

repayment and interest of 10 percent on the

principal. Christen et al. (1995) calculate that

this translates to a 55 percent nominal annualrate and a 46 percent real rate in 1993. Loan

losses in 1994 were just under 4 percent of

loans outstanding (Johnston 1996).

Also as in most micronance programs, loans

do not require collateral. The innovation of

the BKDs is to allocate funds through village-

level management commissions led by village

heads. This works in Indonesia since there

is a clear system of authority that stretchesfrom Jakarta down to the villages. The

BKDs piggy-back on this structure, and the

management commissions thus build in many

of the advantages of group lending (most

importantly, exploiting local information

and enforcement mechanisms) while

retaining an individual-lending approach.

The commissions are able to exclude the

worst credit risks but appear to be relatively

democratic in their allocations. Throughthe late 1990s, most BKDs have had excess

capital for lending and hold balances in BRI

accounts. The BKDs are now supervised by

BRI, and successful BKD borrowers can

graduate naturally to larger-scale lending from

BRI units.

e. Village Banks

Prospects for replicating the BKDs outside

of Indonesia are limited, however. A more

promising, exportable village-based structure

is provided by the network of village banks

started in the mid-1980s in Latin America

by John Hatch and his associates at the

Foundation for International Community

Assistance (FINCA). The village banking

model has now been replicated in over 3000

sites in 25 countries by NGOs like CARE,

Catholic Relief Services, Freedom from

Hunger, and Save the Children. FINCA

programs alone serve nearly 90,000 clients

in countries as diverse as Peru, Haiti,

Malawi, Uganda, and Kyrgyzstan, as well

as in Maryland, Virginia, and Washington,

D.C. The NGOs help set up village nancial

institutions in partnership with local groups,allowing substantial local autonomy over

loan decisions and management. Freedom

from Hunger, for example, then facilitates

a relationship between the village banks

and local commercial banks with the aim to

create sustainable institutional structures.

The village banks tend to serve a poor,

predominantly female clientele similar to that

served by the Grameen Bank. In the standardmodel, the sponsoring agency makes an

initial loan to the village bank and its 3050

members. Loans are then made to members,

starting at around $50 with a four month

term, with subsequent loan sizes tied to the

amount that members have on deposit with

the bank (they must typically have saved at

least 20 percent of the loan value). The initial

loan from the sponsoring agency is kept in

an external account, and interest income isused to cover costs. The deposits of members

are held in an internal account that can be

drawn down as depositors need. The original

aim was to build up internal accounts so that

external funding could be withdrawn within

three years, but in practice growing credit

demands and slow savings accumulation have

limited those aspirations (Candace Nelson et

al. 1995).

Like the Indonesian BKDs, the village banks

successfully harness local information and

peer pressure without using small groups

along BancoSol or Grameen lines. And, as

with the BKDs, sustainability is an aim, with

nominal interest rates as high as 4 percent

per month. Most village banks, however, still

require substantial subsidies to cover capital

costs. Partly, this is because many village


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banks have been set up in areas that are

particularly difcult to serve (e.g., rural Mali

and Burkina Faso), and the focus has been

on outreach rather than scale. Worldwide, the

number of clients is measured in the tens of

thousands, rather than the millions served by

the Grameen Bank and BRI.

Micronance Mechanisms

The ve programs above highlight the diversity

of approaches spawned by the common idea

of lending to low-income households. Group

lending has taken most of the spotlight, and the

idea has had immediate appeal for economic

theorists and for policymakers with a vision of

building programs around households social

assets, even when physical assets are few. Butits role has been exaggerated: group lending

is not the only mechanism that differentiates

micronance contracts from standard loan

contracts.6 The programs described above also

use dynamic incentives, regular repayment

schedules, and collateral substitutes to help

maintain high repayment rates. Lending to

women can also be a benet from a nancial

perspective.

As shown in Table 1, just two of the ve

use explicit group-lending contracts, but

all lend in increasing amounts over time

(progressive lending), offer terms that are

substantially better than alternative credit

sources, and cut off borrowers in default.

Most also require weekly or semi-weekly

repayments, beginning soon after loan receipt.

While we lack good evidence on the relative

importance of these mechanisms, there is

increasing anecdotal evidence on limits to

group lending per se (e.g., the village studies

from Bangladesh in Aminur Rahman 1998;

Imran Matin 1997; Woolcock 1999; Sanae

Ito 1998; and Pankaj Jain 1996). This section

highlights what is known (or ought to be

known) about the diversity of technologies

that underlie repayment rates and screening

mechanisms.

Peer Selection

Group lending has many advantages,

beginning with mitigation of problems created

by adverse selection. The key is that group-

lending schemes provide incentives for similar

types to group together. Ghatak (1999) shows

how this sorting process can be instrumentalin improving repayment rates, allowing

for lower interest rates, and raising social

welfare. His insight is that a group-lending

contract provides a way to price discriminate

that is impossible with an individual-lending

con rac .7

To see this, imagine two types of potential

investors. Both types are risk neutral, but

one type is risky and the other is safe;the risky type fails more often than the

safe type, but the risky types have higher

returns when successful. The bank knows

the fraction of each type in the population,

but it is unable to determine which specific

investors are of which type. Investors,

though, have perfect information about

each other.

Both types want to invest in a project withan uncertain outcome that requires one unit

of capital. If they choose not to undertake

the project, they can earn wage income

m. The risky investors have a probability

of success pr and net return Rr. The safe

investors have a probability of success ps

and net return Rs. When either type fails,

the return is zero. Returns are statistically

independent.

Risky types are less likely to be successful

(pr < ps), but they have higher returns when

they succeed. For simplicity, assume that

the expected net returns are equal for both

safe and risky_ types: prRr = psRs = R. The

projects of both types are socially protable

in that expected returns net of the cost of

capital, ., exceed earnings from wage labor:

_ R -.> m.


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able 1

Characteristics of Selected

eading Micro-nance Programs

Grameen

Bank,

Bangladesh

anco-

Sol,

olivia

Bank

Rakyat

IndonesiaUnit Desa

Badan

redit

Desa,Indonesia

FINCA

Villageanks

embership 2.4 million 81,503

2 million

borrowers;

16 million

depositors

65,586 89,986

Average loan balance $134 $909 $1007 $71 $191

Typical loan term 1 year412

months

324

months3 months months

ercent female members 95% 61% 23% 95%

ostly rural? Urban? rural urban ostlyrural

rural mostlyrural

Group-lending contracts? yes yes no no no

Collateral required? no no yes no no

Voluntary savings emphasized? no yes yes no yes

rogressive lending? yes yes yes yes yes

egular repayment schedules weekly exible exible exible weekly

Target clients for lendingLargely

non-poor-

Currently nancially

sustainable?no yes yes yes no

Nominal interest rate on loans

per year)

20% 47.5 50.5% 3243% 55% 3648%

Annual consumer price

nation 19962.7% 12.4% 8.0% 8.0% __

Sources: Grameen Bank: through August 1998, www.grameen.com; loan size is from December 1996, calculated

by author. BancoSol: through December 1998, from Jean Steege, ACCION International, personal communication.

Interest rates include commission and are for loans denominated in bolivianos; base rates on dollar loans are

2531%. BRI and BKD: through December 1994 (BKD) and December 1996 (BRI), from BRI annual data

nd Don Johnston, personal communication. BRI interest rates are effective rates. FINCA: through July 1998,

www.villagebanking.org. Ination rate: World Bank World Development Indicators 1998.

Neither type has assets to put up as collateral,

so the investors pay the bank nothing if the

projects fail. To break even, the bank must set

the interest rate high enough to cover its per-

loan capital cost, .. If both types borrow, the

equilibrium interest rate under competition

will then be set so that rp =., where p is

the average probability of success in the

population. Since the bank cant distinguish

between borrowers, all investors will face

interest rate, r. As a result, safe types have

lower expected returns than risky typessince

R - rps < R - rpr and the safe types will

enter the market only if their expected net


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return exceeds their fallback position: R - rps

> m. If the safe types enter, the risky types

will too.

But the safe types will stay out of the_ market

if R - rps < m, and only risky that case, the

equilibrium interest rate will rise so that rpr

= .. Risky types drive out the safe. The riskytypes lose the implicit cross-subsidization

by the safe types, while the safe types lose

access to capital. This second-best scenario is

inefcient since only the risky types borrow,

even though the safe types also have socially

valuable projects.

Can a group-lending scheme improve on this

outcome? If it does, it must bring the safe

types back into the market. For simplicity,consider groups of two people, with each

group formed voluntarily. Individuals invest

independently, but the contract is written

to create joint liability. Imagine a contract

such that each borrower pays nothing if her

project fails, and an amount r* if her project

is successful. In addition, the successful

borrower pays a joint-liability payment c*

if the other member of the group fails.8 The

expected net return of a safe type teamed witha _ risky type is then R - ps(r*+(1 - pr)c*),

with similar calculations for exclusively safe

and exclusively risky groups.

Will the groups be homogeneous or mixed?

Since safe types are always preferred as

partners (since thei

on micro enterprise development by ramon t. ayco

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