theARCproject;

FAQs about Microfinance

1. What is microfinance?

"Microfinance is the supply of loans, savings, and other basic financial services to the poor." (CGAP)

As the financial services of microfinance usually involve small amounts of money – small loans, small savings etc. – the term "microfinance" helps to differentiate these services from those which formal banks provide.

Why are they small? Someone who doesn't have a lot of money isn't likely to want to take out a $5,000 loan, or be able to open a savings account with an opening balance of $1,000. Hence – "micro".

2. What is an MFI?

A microfinance institution (MFI) is an organization that provides microfinance services, ranging from small non-profit organizations to large commercial banks.

"Historical context can help explain how specialized MFIs developed over the last few decades. Between the 1950s and 1970s, governments and donors focused on providing subsidized agricultural credit to small and marginal farmers, in hopes of raising productivity and incomes. During the 1980s, microenterprise credit concentrated on providing loans to poor women to invest in tiny businesses, enabling them to accumulate assets and raise household income and welfare. These experiments resulted in the emergence of nongovernmental organizations (NGOs) that provided financial services for the poor. In the 1990s, many of these institutions transformed themselves into formal financial institutions in order to access and on-lend client savings, thus enhancing their outreach.

An MFI can be broadly defined as any organization—credit union, down-scaled commercial bank, financial NGO, or credit cooperative—that provides financial services for the poor." (CGAP)

"The World Bank estimates that there are now over 7000 microfinance institutions, serving some 16 million poor people in developing countries. The total cash turnover of MFIs world-wide is estimated at US$2.5 billion and the potential for new growth is outstanding." - Data Snapshots on Microfinance - The Virtual Library on Microcredit







3. What are the effects of microfinance?

"Comprehensive impact studies have demonstrated that:

• Microfinance helps very poor households meet basic needs and protect against risks;
• The use of financial services by low-income households is associated with improvements in household economic welfare and enterprise stability or growth;
• By supporting women's economic participation, microfinance helps to empower women, thus promoting gender-equity and improving household well-being;
• For almost all significant impacts, the magnitude of impact is positively related to the length of time that clients have been in the programme." (UNCDF Microfinance)

"Poor people, with access to savings, credit, insurance, and other financial services, are more resilient and better able to cope with the everyday crises they face. Even the most rigorous econometric studies have proven that microfinance can smooth consumption levels and significantly reduce the need to sell assets to meet basic needs. With access to microinsurance, poor people can cope with sudden increased expenses associated with death, serious illness, and loss of assets.

Access to credit allows poor people to take advantage of economic opportunities. While increased earnings are by no means automatic, clients have overwhelmingly demonstrated that reliable sources of credit provide a fundamental basis for planning and expanding business activities. Many studies show that clients who join and stay in programs have better economic conditions than non-clients, suggesting that programs contribute to these improvements. A few studies have also shown that over a long period of time many clients do actually graduate out of poverty.

By reducing vulnerability and increasing earnings and savings, financial services allow poor households to make the transformation from "every-day survival" to "planning for the future." Households are able to send more children to school for longer periods and to make greater investments in their children's education. Increased earnings from financial services lead to better nutrition and better living conditions, which translates into a lower incidence of illness. Increased earnings also mean that clients may seek out and pay for health care services when needed, rather than go without or wait until their health seriously deteriorates." (CGAP)

"Empirical evidence shows that, among the poor, those participating in microfinance programs who had access to financial services were able to improve their well-being—both at the individual and household level—much more than those who did not have access to financial services.

• In Bangladesh, Bangladesh Rural Advancement Committee (BRAC) clients increased household expenditures by 28% and assets by 112%. The incomes of Grameen members were 43% higher than incomes in non-program villages.
• In El Salvador, the weekly income of FINCA clients increased on average by 145%.
• In India, half of SHARE clients graduated out of poverty.
• In Ghana, 80% of clients of Freedom from Hunger had secondary income sources, compared to 50% for non-clients.
• In Lombok, Indonesia, the average income of Bank Rakyat Indonesia (BRI) borrowers increased by 112%, and 90% of households graduated out of poverty.
• In Vietnam, Save the Children clients reduced food deficits from three months to one month." (CGAP)
It's easy to imagine poor people don't need financial services, but when you think about it they are using these services already, although they might look a little different.

"Poor people save all the time, although mostly in informal ways. They invest in assets such as gold, jewelry, domestic animals, building materials, and things that can be easily exchanged for cash. They may set aside corn from their harvest to sell at a later date. They bury cash in the garden or stash it under the mattress. They participate in informal savings groups where everyone contributes a small amount of cash each day, week, or month, and is successively awarded the pot on a rotating basis. Some of these groups allow members to borrow from the pot as well. The poor also give their money to neighbors to hold or pay local cash collectors to keep it safe.

However widely used, informal savings mechanisms have serious limitations. It is not possible, for example, to cut a leg off a goat when the family suddenly needs a small amount of cash. In-kind savings are subject to fluctuations in commodity prices, destruction by insects, fire, thieves, or illness (in the case of livestock). Informal rotating savings groups tend to be small and rotate limited amounts of money. Moreover, these groups often require rigid amounts of money at set intervals and do not react to changes in their members' ability to save. Perhaps most importantly, the poor are more likely to lose their money through fraud or mismanagement in informal savings arrangements than are depositors in formal financial institutions."- (CGAP)




Can microfinance be profitable?

Yes.

"The November 2001 issue of the MicroBanking Bulletin includes data from 62 self-sufficient MFIs. The average return on assets for this group is 5.5%, which compares favorably to commercial-bank returns. Indeed, there are grounds for hope that microfinance can become attractive to mainstream retail bankers.

At the same time, some worry that an excessive concern for profit in microfinance will lead MFIs away from poor clients to serve better-off clients who want larger loans. It is true that programs serving very poor clients are somewhat less profitable than those reaching better-off clients, but this may say more about managers' objectives than an inherent conflict between serving the very poor and profitability. MFIs serving the very poor are showing rapid financial improvement. Microfinance programs like Bangladesh Rural Advancement Committee and ASA in Bangladesh have already demonstrated that very poor clients can be reached profitably: both institutions had profits of more than 4% of assets in 2000.

There are cases where microfinance can not be made profitable, for example, where potential clients are extremely poor and risk-averse or live in remote areas with very low population density. In such settings, microfinance may require continuing subsidies. Whether microfinance is the best use of these subsidies will depend on evidence about its impact on the lives of these clients." (CGAP)