2Challenges to the Field and Solutions:Overindebtedness, Client Dropouts,Unethical Collection Practices,Exorbitant Interest Rates, Mission Drift,Poor Governance Structures, and MoreAnton Simanowitz When years turn our vision dim and grey, we shall still see the beauty in the tired wrinkles of our face; we will find comfort in the wisdom and knowledge of the fact that we did all that we could in our power to achieve our goals. Equity Bank, Kenya—Part of internal inspiration statement, used to give direction and mission to employees.At the core of microfinance is a concern for people. About 1 billion people starttheir day uncertain about whether they will get enough food that day to satisfytheir hunger, while a further 1.5 billion people have the basics, but struggle toimprove their conditions, and are always aware that they are one crisis awayfrom the daily battle that faces the poorest people.1 My starting point is the needs of clients and potential clients—a perspectivethat is unfortunately heard less and less as microfinance focuses on buildingsustainable institutions rather than sustainable clients. I argue that the startingpoint needs to be an understanding of the experiences, challenges, and needs ofthe different groups of people an MFI serves. This approach allows for prod-ucts and services to be designed and delivered that are appropriate to theirneeds, and for processes and systems to be refined so that they are efficient andeffective from the client’s point of view. 53
54 NEW PATHWAYS OUT OF POVERTY This chapter looks at how the ideals of microfinance can be achieved, andthe factors that inhibit it from achieving its potential. In writing this I have con-sulted with many people,2 and almost without exception, the social value ofmicrofinance is highlighted as the foundation. Even where delivered throughfor-profit, commercially focused institutions, ultimately microfinance is seen asa means to an end. Few would see profit as their sole reason for working inmicrofinance. The first section of the chapter addresses some of the more visible and prac-tical challenges highlighted by crises in some markets. Clients experience thesechallenges directly in the quality and scope of services they receive, how they aretreated by the MFIs’ staff, and ultimately in what value or harm is created byusing the services. While some people see the recent crises as isolated incidents, the majorityfeel that fundamental lessons need to be learned. Overall, a broad range ofmicrofinance actors reject media suggestions that perhaps microfinance itself isa flawed idea, but highlight the need for the microfinance community to reex-amine assumptions and find ways to increase effectiveness. Central to this stanceis increasing focus on clients, to achieve a more conscious and transparent bal-ance between the social and commercial goals in all aspects of strategy and man-agement (see also the chapter by Frances Sinha on the seal of excellence inmicrofinance). I focus primarily on so-called credit-led microfinance, an approach that cre-ates large, financially sustainable institutions that build a physical infrastructureto deliver financial services, and fund these services primarily through interestcharged on loans (as well as fees and other charges). I also consider alternativeapproaches to microfinance, and examine the extent to which the challengesare common. The second section of the chapter focuses on solutions and presents a man-ifesto for client-focused microfinance. This section focuses on four areas: • Deepening financial inclusion: overcoming exclusion of poor, vulnerable, and marginalized groups. • Creating value for clients: starting with clients and their needs, and build- ing sustainable institutions that deliver value. • Protecting clients from harm: recognizing client risk and vulnerability in regulation, governance, and systems to protect clients. • Ensuring quality of microfinance services: developing effective manage- ment systems to deliver on these objectives.
Challenges to the Field and Solutions 55 STATE OF PRACTICE— CHALLENGES TO MICROFINANCE I think we have done great harm in excessively hyping microfinance. The reality and [myth] are so far apart that it creates unrealistic expec- tations for industry. Asad Mahmood, Deutsche Bank3Microfinance is recognized as an important development intervention. Accessto financial services can both protect and promote poor people’s livelihoods,helping them better plan for anticipated financial needs, cope with crises andemergencies, and invest in economic opportunities such as a microenterprise toimprove their income. Financial access in turn can lead to improved access tobasic necessities such as food, clothing, shelter, health, and education. Comple-mentary nonfinancial services and the positive support of staff or group mem-bers can help to facilitate these outcomes. Microfinance also provides a platformfor integrating or linking to a range of other developmental services. Microfinance is also an industry that is coming of age, with impressivegrowth in numbers of clients, exceeding 50% per annum in many countries.4The Microcredit Summit 2011 Campaign reports an increase in credit cus-tomers from 23.5 million to 190.1 million between 2000 and 2010, and an in-crease from 1,567 to 3,589 microfinance institutions (MFIs) reporting to thecampaign.5 Microfinance has grown to become big business, with more thanUS$4 billion now invested through 78 microfinance investment vehicles, mak-ing up a worldwide industry valued at more than US$65 billion.6 Yet the potential market for microfinance remains vast, with some 3 billionadults lacking access to even basic formal financial services.7 The challenge ofscale has been the driving concern over the past decade. Rapid growth demandsaccess to increasing amounts of capital. Commercialization—which allowsMFIs either to access capital through savings mobilization or through the cap-ital markets—is a key aspect of this approach. For many, the successful initial public offering (IPO) of Compartamos inMexico in 2007 and SKS in 2010 validate this approach, with ACCION, for ex-ample, commenting, “The financial markets have shown the true value createdby high-performance, double bottom line–oriented microfinance institutions.”8 But the win-win vision of a business approach to solving social problems isunder attack. The IPOs in Mexico and India highlight the potential for micro-finance to attract investment driven predominantly by profit. The success of theseIPOs (not least for the MFI directors and investors) has led to moral outrage in
56 NEW PATHWAYS OUT OF POVERTYsome quarters, and a sense of disquiet in others. There is particular concern whenhigh interest rates are perceived to drive high financial returns for the investorsin microfinance, rather than efficiency gains being translated into lower costsfor clients. Although Compartamos enjoyed high levels of client satisfaction, itsinterest rates were relatively high for the Mexican market (and at around 100%APR very high internationally). These rates were justified as generating capitalfor growth, but following the commercialization of the bank, interest rates weremaintained, generating returns of 100% annually, and fueling the huge interestin the IPO. Rich Rosenberg writing for CGAP9 asks, “To what extent do theprofits come out of the pockets of poor customers? And are the profits used forfurther service to more poor people, or do private investors capture them?” Meanwhile the erosion of client livelihoods through increasing energy andfood prices, recession, and retrenchment is leading to client overindebtednessand delinquency, and exposing weaknesses in MFI systems overstretched byrapid growth.10 There are reports of increasing unethical practices by field staffchasing high productivity targets. The Centre for the Study of Financial Inno-vation (CSFI) Banana Skins report for 2011 concluded that credit risk is nowthe number-one challenge for MFIs, demonstrating the challenges to the veryfoundation of microcredit—the ability of clients to repay their loans. Although commercialization allows microfinance to achieve scale, increasingthe number of clients is, by itself, an indicator neither of positive impact nor thestrength of an institution. Although some believe that providing access to financialservices is by definition a socially useful activity, experience has shown that socialoutcomes of microfinance are not automatic but rather the result of prudent strat-egy, design, management, and governance. As the recent global financial crisisdemonstrates, social performance in financial services cannot be taken for granted. The benefits of microfinance are being questioned, too. Academic studies overmany years have reported generally positive but inconsistent impacts of micro-finance,11 and recent studies have failed to find widespread and consistent povertyreduction impact.12 The lack of generalizable results has been picked up by an in-ternational media quick to highlight the shortcomings of microfinance. In part,microfinance has been overhyped, characterized by many as the silver bullet in thefight against poverty. Although most practitioners would recognize this as a hugeexaggeration, the claim is seldom challenged by those inside the industry and in-deed perpetuated by glossy promotional stories of client successes. It is time is re-focus on how to achieve and demonstrate positive outcomes for clients. Crisis in Some Competitive MarketsThere is a consensus from my conversations that in overheated markets thereare real challenges that have the potential to both harm clients and prevent
Challenges to the Field and Solutions 57microfinance from fulfilling its potential for positive impact, as well as damag-ing the financial performance of the sector. “We have moved beyond anec-dotes,” says Jean-Pierre Klump from Blue Orchard, a microfinance investmentvehicle. “The microfinance industry, although still young, has reached a level ofmaturity [such] that recent events can be seen as systematic and need to be takenseriously.”13 While competition and commercialization can stimulate improvements inclient service and improved efficiency, MFIs can compete equally by simplifyingtheir products or pushing credit, insurance, and other products to increase prof-its. In some cases, concentrated competition has clearly led to negative conse-quences, particularly in India where there is the added pressure of investorexpectations and the lack of balance created by regulatory prohibitions on deposittaking. Many people highlight the particular danger of the combination of rapidgrowth and competition, combined with weak regulation. Citing the examples ofcountries such as Nicaragua, Bosnia, Morocco, and Pakistan, a CGAP reportconcludes, “Microfinance grew remarkably rapidly but the repayment problemsnow evident in these four countries suggest that growth came at a cost.”14 In rapidly growing organizations, developing and retaining the necessarystaff capacity to effectively deliver quality services is a challenge. High rates ofgrowth put huge pressures on management systems, challenging the ability toensure consistency in service delivery. This has been the experience of manyMFIs—in both competitive and less competitive markets. Reille highlights theloss of quality and efficiency of staff, the focus and effectiveness of middle man-agement, and the inadequacy of internal controls: “The drive towards scale alsobrings with it a preoccupation with rapid expansion that can easily erode goodbanking principles, to the detriment of the institution (in the form of deterio-rating portfolio quality) and of clients (in the form of over-indebtedness).”15 For the first time, most of the money in microfinance comes from privateinvestors. There is a sense that the growth of commercial investors leads to achange of focus with more emphasis on short-term returns and a concern thatinvestors will push MFIs to maintain relatively high interest rates in order togenerate high rates of return. Importantly, publicly listed companies have a legalobligation to maximize return for their shareholders. Chen et al. highlight theconcern that “excessive commercialisation will tilt the gains heavily toward in-vestors at the expense of the poor.”16 Maya Prabhu, head of philanthropy atCoutts, a private UK bank, advises wealthy clients on investments in micro-finance. She concurs and feels that “there is definitely a risk of new sharehold-ers switching MFIs’ missions from alleviating poverty to chasing volumes andprofits.”17 One particular example highlighted by the experience in India is the moveto generate loan capital through the capital markets rather than through deposit
58 NEW PATHWAYS OUT OF POVERTYtaking. This is seen by many to encourage people who may not understandsome of the fundamentals of microfinance to prioritize short-term financial re-turns: “There is a lot of greed coming into microfinance. A lot of people wishto make a lot of money out of it, and that worries me.”18 Challenges of a Focus on Growth and Efficiency Quality must come first. We try to grow as fast as we can in a way that we protect the quality of what we do and products that we give to the clients. Carlos Danel, Compartamos19In most regions of the world, competitive microfinance markets are a long wayoff, yet growth in client numbers, portfolio size, and efficiency remain the dom-inant benchmarks of success. There is a strong sense from my conversationsthat the highly competitive markets are extreme examples of issues that applymore generally to credit-focused microfinance that pursues institutional growthand sustainability without an equal focus on client growth and sustainability.“In a heated marketplace all of the systemic issues that were present rise to thefore and get out of control,” states Frank DeGiovanni.20 These challenges arepresent from day one. Decisions made in the name of growth and efficiency often directly under-mine some of the core aspects of an MFI’s methodology and systems key to en-suring outreach, value, and protection for target clients. Often changes are madewithout a full understanding of what they imply for social as well as financialperformance. There are challenges in a number of areas. Mission Drift Mission drift is not an exclusive risk of commercial MFIs. It’s a risk in all MFIs. Kimanthi Matua, K-Rep21A focus on growth and efficiency leads MFIs to focus on clients who are easyto reach and who have a secure existing income with which to repay a loan.Poorer, more vulnerable people with insecure incomes or living in remote areasare not an obvious choice of client. Evidence from a study by Women’s WorldBanking (WWB)22 and others suggests that organizations that strongly focus ongrowth in client numbers, portfolio, and efficiency are likely to move away fromhard-to-reach areas, and from women and poorer clients to more profitableand easier-to-reach clients. Matua states, “Many of us have witnessed mission
Challenges to the Field and Solutions 59drift happen from pressure from donors, regulators, managers, staff, and evenclients themselves.”23 This is particularly the case where an MFI transforms intoa for-profit institution where greater pressure may exist to generate financialreturns for investors. Transformation also leads to an expansion of the MFI’sclient base to include savers outside the traditional target group. Matua alsoreports, “When you transform you begin to attract depositors from all segmentsof market, as that is the only way you can grow. But depositors demand thingsbecause they give you something, they demand certain services, so they influencepolicy. They influence you to move somewhere away from your original micro-finance customers. It is a continuous process to make sure you balance this cre-ative tension.” MFI SystemsA combination of fast growth and efficiency has the potential to undermineMFI systems and internal control. Growth puts a strain on management systemsas relatively inexperienced people are promoted and new staff are trainedquickly. Efficiency has often been achieved through simplifying processes suchas internal control, loan appraisal, hiring practices, and increasing staff pro-ductivity. MicroSave, for example, outlined concerns about the ability of In-dian MFIs to manage their exponential growth: “There was a marked absenceof control systems over the maintenance of cash and cheques; many brancheswhere the entire staff had less than one year of experience and branch man-agers being transferred and replaced in less than a month; lack of properly doc-umented policies in HR, Operations and Accounts . . . the list goes on.”24 RelationshipsExcessive growth and competition result in organizational systems beingstretched or streamlined in order to reduce costs, leading to reduced staff-clienttime and a deterioration in relationships. In India, for example, staff produc-tivity has been increased to very high levels, with caseloads increasing fromfewer than 400 clients per loan officer in 2007 to more than 500, and in onecase over 900,25 a point at which staff members can have very little knowledgeof their clients. Pressure on field staff to grow their portfolios and ensure high repaymentrates, despite problems experienced by clients, often leads to short-cuts beingtaken (as in assessments of capacity to repay) and sometimes harsh collectionpractices (discussed later in the chapter). In group lending situations, it puts fullreliance on repayment assessments on the groups. Malcolm Harper highlightsthe importance of this reduction of time with clients: “What matters is good
60 NEW PATHWAYS OUT OF POVERTYpersonal service. MFI staff with the ability and time to think, to take a view onwhether the household can afford the repayments, on their other debts and soon. . . . I think it’s called ‘relationship banking.’”26 Client ValueWhere efficiency leads to simplified processes and a small number of standard-ized products and services, the MFI likely becomes less effective at meeting theneeds of clients. Linked to this is the WWB’s finding that MFIs often make cutsto program aspects important for deepening outreach and creating value forclients. Activities such as cash-flow-based credit analysis, client training, busi-ness development services, and client assessment are often the first to go. JulieSlama of the WWB explains, “These are the very programs that would allowMFIs to profitably serve poor women, and without which, women will eitherchoose not to take loans or will fail as borrowers.”27 Often cuts may have agreater impact on the needs of women who may benefit most from nonfinan-cial services or have smaller businesses. Interestingly, even some of the most commercially focused organizations,such as Compartamos, recognize that a push for short-term growth is a riskystrategy, and that microfinance needs to be focused on long-term value for clients:through delivering products and services responsive to client needs and ensuringquality in the delivery of these services. Vikram Akula of SKS similarly believesthere is no intrinsic tension between profit and impact: “[Good business] is notabout extracting from the poor, but doing what is right for customers.”28 OverindebtednessA key experience in competitive markets has been the phenomenon of increas-ing clients’ access to credit through more relaxed lending policies and multiplelending. Beth Rhyne describes how, prior to the crisis in microfinance in Bo-livia in the 1990s, “Suddenly, women who had had limited access to credit werespoilt for choice; many borrowed from multiple lenders.”29 Similarly, prior tothe collapse of Banex in Nicaragua in 2010, MFIs competed by increasing loansizes. According to Barbara Magnoni of EA Consultants, “Microentrepreneurswere being offered Mother’s Day loans, Christmas loans, loans for the begin-ning of school, housing loans, home improvement loans, educational loans, mo-torcycle loans and more.”30 Even where some MFIs are strict about their lending criteria, this does notstop other institutions lending to the same clients. Multiple lending is seen to bea significant issue in competitive markets. For example, in Andhra Pradesh,India, there are loans outstanding to more than 20 million microfinance clients,
Challenges to the Field and Solutions 61while the number of households is about 16 million, demonstrating a high levelof multiple borrowing.31 Many people are careful not to overindebt themselvesand may have genuine need for multiple loans, but experience clearly demon-strates that easy access to credit, particularly at times of financial stress or in thecontext of pressure for consumption, can lead to clients making bad decisions.The CSFI Banana Skins report for 2011 identifies overindebtedness as the majorcause for credit risk: “The problem is so severe that it could lead to a possibleimplosion of some of the key players. . . . Increased delinquencies, program de-terioration, damage to clients’ well-being . . . we’re seeing this issue crop up intoo many markets.”32 Toward Improved “Relationship Banking”These challenges get to the very heart of microfinance as a business approachto solving social problems. There is a sense that a refocus is needed on under-standing and responding to clients, and improving the quality, management,governance, and regulation of services to create value for clients. For micro-finance to deliver on its double bottom line, increasing scale and commercialfocus must combine with renewed attention to clients and innovation to ensurethat services are designed and delivered in the most effective as well as efficientway. Clearer standards and transparency are also essential to ensure that clientsare empowered to make informed decisions about the services they purchase,and that they are protected from bad practice. DEEPENING FINANCIAL INCLUSION: OVERCOMING EXCLUSION OF POOR, VULNERABLE, AND MARGINALIZED PEOPLE I thought I was too poor to join, but now I’m very proud to be part of my Credit Association.33One of the most appealing aspects of microfinance is its potential to extend fi-nancial services to the 2.7 billion people without access to them. But there is un-evenness of outreach, a trend of moving upmarket, and a number of groups ofpotential clients that tend to be excluded. Women. Although microfinance has traditionally targeted women, recentdata from a study by Women’s World Banking shows that this trend is chang-ing. The study shows a clear trend toward a declining focus on women clientsonce an MFI becomes a regulated, for-profit financial institution. In a sampleof 27 MFIs that had made the transition from NGOs, the percentage of women
62 NEW PATHWAYS OUT OF POVERTYclients served fell from an average of 88.5% in the year prior to the transitionto 68.5% within four years of that transformation.34 Women generally ownbusinesses that are smaller in size than those of men; they have smaller cashflows and hence a lower capacity to absorb higher debt amounts than that ofmen, and women are therefore seen as less desirable clients. MFIs also maymove away from women clients due to the need for higher profitability result-ing from increased average loan sizes. Remote and rural areas. MFIs that deliver financial services directly need tobuild up a large and costly infrastructure, which puts pressure on the organi-zation to grow to scale and to drive down costs of delivery. The tension be-tween the cost of the MFI’s infrastructure and the capacity of clients to reliablypay for services lies at the heart of the challenge of outreach. It also pushes MFIsto focus on provision of credit that can generate an income, rather than savings,which requires a larger infrastructure to mediate very small transactions fromlarge numbers of people. It is therefore unsurprising that MFIs find it hard toreach remote areas, and tend to focus on clients with a good existing capacityto absorb credit. Community-based models provide a lower-cost alternative to building upthe institutional infrastructure of credit-led microfinance, allowing for accessto more remote and rural areas. Groups are facilitated to mobilize and on-lendtheir own savings. The groups are trained and then can become sustainable, re-quiring minimal ongoing external support. Groups can often replicate withoutexternal involvement. A significant subsidy is needed to facilitate the capacitybuilding of these groups, but proponents of this approach argue that this sub-sidy is far less than the millions of dollars that go into building a sustainableMFI, and that this is a lower risk approach where ultimately all the benefitscome back to the clients. Jeffrey Ashe of Oxfam-America argues that “savings-led microfinance could provide access for much less than credit-led. The modeloffers great potential to have millions of member-owned, member-managed andmember-used organizations of the poor.”35 Poor, vulnerable, and marginalized people. Most microfinance—includingcommunity-based models—tends to exclude a significant number of the poorerand more vulnerable population. Although the Microcredit Summit has cam-paigned since 1997 to increase the poverty focus of microfinance, broadly inmost countries and most types of microfinance organizations, clients are pre-dominantly those people just below and just above the poverty line. Servicesrarely extend to the very poor. For microcredit to be appropriate, the clients must have the capacity torepay the loan under the terms by which it is provided. Where there is little tono access to markets and very little cash in the community to support local busi-nesses, there may be little value in credit, or it may be seasonal. Vulnerable
Challenges to the Field and Solutions 63clients may also fear the risk of credit or just not having the confidence to join:“It is very likely that we would spend the loan (to pay for food) and that wewould be incapable of repaying it properly. So, that could create problems thatwe would rather avoid.”36 In other cases, even very poor people have beenshown to value and productively use credit. There is also broad acceptance thataccess to savings is a critical need for even the poorest people. Decisions needto be made on the basis of understanding rather than assuming that certain ser-vices are suitable or unsuitable. Factors Toward ExclusionMost MFIs serve a relatively small proportion of their total potential market,deliberately or inadvertently excluding certain groups. A number of factors leadto the exclusion of the groups mentioned previously. Enterprise credit. Numerous MFIs only lend to people who have an exist-ing microenterprise rather than supporting start-ups, which are riskier and oftenrequire training and support in addition to credit. These organizations effec-tively exclude the vast majority of people who lack access to financial services. MFIs’ policies and procedures. Many MFIs set eligibility criteria that serveto exclude more vulnerable and poorer clients—for example, registration fees,minimum loan sizes, or minimum savings balances. Gender biases are oftenpresent, such as discrimination against women that occurs when clients are re-quired to show title deeds for their land or house. In addition to these policies,MFIs often inadvertently exclude people through inappropriate products andservices, or make changes in pursuit of efficiency that may have the side effectof removing aspects of the methodology that favor weaker clients—for exam-ple, removing client training or home visits. In addition, staff actions and decisions respond to organizational culture,personal biases, or incentives, and have considerable influence over whom theorganization serves. Many MFIs have a culture that rewards growth in clientnumbers and portfolio size. The organization thus tends to focus on moreeasy-to-reach areas and clients. Management responds by selecting opera-tional areas in urban and peri-urban locations, or in the market center closeto the main road in rural areas. Field staff respond by targeting easy-to-reachpeople, and those who are able to take a relatively large loan and grow it overtime (see Box 2.1). There are norms in society that lead to the poorest people and other groups,such as the disabled, being regarded as inadequate and incapable of achieving.These norms are reflected in self-perceptions as well as perceptions among thewider community, MFI field staff and management, and the microfinance indus-try. Poorer people are commonly viewed as potentially problematic by field staff
64 NEW PATHWAYS OUT OF POVERTY Box 2.1 Staff Response to Exclusion in Malawia During a workshop at Microloan Foundation, Malawi, staff made a com- mitment to try to deepen their outreach by addressing exclusion factors such as the bias of serving clients close to the branch office. Subsequently, a manager returned to her branch and approved two groups that she had been intending to reject because of their location in a more remote rural area. Note: a. Personal correspondence.and avoided. In Latin America, for example, the term “poor” implies laziness,drunkenness, and lack of judgment. Without addressing these issues explicitly,MFIs tend to reflect these patterns that lead to marginalization. Exclusion by group members. Microfinance groups are normally self-selecting in terms of membership and play a role in setting loan size. A commonexperience in groups—of all methodologies—is that they are dominated bystronger members, who may exclude weaker individuals from joining or limittheir ability to participate. This is particularly the case in groups for which ac-cess to credit is dependent on the level of saving in the group, or in solidaritylending where clients must guarantee each other’s loans. Exclusion through external factors. Regulation may also serve to excludeand can be a driver of mission drift by inadvertently making it more costly orcomplex for an MFI to serve its target clients. Examples include requiring allclients of MFIs to have national identification cards; classifying all loans to in-formal business as consumer rather than enterprise loans, thus requiring higherprovisioning for portfolio at risk; or a requirement to make credit bureau checksbefore lending, where this may cost 10% to 15% of the loan, and prove im-practical when trying to get groups in remote rural areas to make decisionsabout their loans. Overcoming Exclusion Organizations that seek to reach certain groups do so. It’s a question of will. Anonymous survey respondent37If a goal of microfinance is financial inclusion, then the challenge is to reachout to those people who could benefit from financial services who are currentlyexcluded. Where an MFI defines particular target clients, products and services
Challenges to the Field and Solutions 65should be designed to meet their needs, and that outreach is monitored andmanaged. In addition, many MFIs have the potential to deepen their outreachby understanding factors that lead to exclusion of potential clients, and makingadjustments in response. While poorer, vulnerable, and more remote clients may be more costly orrisky to serve, considerable evidence exists that these trade-offs are not auto-matic.38 When MFIs put effort into designing their programs to serve thesegroups, the difference can be dramatic, and can be accomplished sustainably.For example, often with targeted communication and an appropriate organi-zational culture, services can be made more conducive to these potential clientgroups. A focus on savings rather than credit—at least initially—may often bemore appropriate. Guy Vanmeenen describes the approach of Catholic ReliefServices (CRS) in working with savings and credit groups. CRS began by form-ing a group with those who are less risk adverse and not the poorest. Afterabout eight to 10 months, once the group has shared out their savings, a demon-stration effect takes place and others see the benefits. Effort is then needed toform subsequent groups within the same community, and to include groups witha lower minimum savings balance to ensure the inclusion of the poorer people.More savings groups continue to be formed until the market is saturated.39 Thefollowing two examples illustrate approaches to deepening financial inclusion.AMK, CambodiaAMK demonstrates the practical steps an MFI can take to overcome exclusionand deepen financial inclusion. AMK has been ranked number 17 in the world’stop 100 MFIs, serving 250,930 clients with 108% operational self-sufficiencyas of December 2010. It is also notable for its focus on serving poor women inrural areas, with around 90% of its clients rural, 86% female, and 56% belowthe national poverty line. Plus AMK has Cambodia’s lowest average loan out-standing at US$115, compared to a national average of US$411. It has deepenedits outreach through a series of steps. Segmenting its client market and adapting services to their specific needs.AMK does not directly target women or the poor; instead it attracts its chosentarget group through maintaining relatively low loan ceilings on products, andselecting rural operational areas with higher than average poverty rates. AMKhas also adapted its savings and loans products to the specific needs of ruralagricultural households, with flexibility of loan terms and timing, and the op-tion of installment or end-of-term loans. Creating appropriate organizational culture and staff incentives. AMK hasbeen particularly successful in building and maintaining a social performanceculture in a context of rapid growth, and retaining this as personnel, manage-ment, and board members change. Regular reports on social performance serve
66 NEW PATHWAYS OUT OF POVERTYto keep attention focused on the social aspects of the mission, and have led tointegrating related reporting into other departments—for example: • Making social performance a core element of formal staff training. • Incorporating a social dimension into staff appraisal through HR and an in- ternal audit. • Including in staff incentives a difficulty rating that takes into account more challenging rural environments.Small Enterprise Foundation (SEF), South AfricaIn the case of SEF in South Africa, some relatively simple steps—including start-up businesses and poverty targeting—successfully transformed a program thatwas serving predominantly women above the poverty line, MCP (formerlyMicrocredit Programme), into one that serves predominantly very poor women,TCP (formerly Tshomisano Credit Programme). Figure 2.1, illustrating resultsfrom the CGAP poverty assessment of SEF, shows a huge difference in povertyoutreach.40 While MCP predominantly reaches clients from the least poor groupand has few clients from among the poorest third, TCP is biased toward poorerpeople. What is more, despite smaller initial loans and the costs associated withpoverty targeting, lower arrears and higher client retention in TCP mean that,in the long term, the programs are roughly comparable in terms of their finan-cial performance.Figure 2.1 Comparing Poverty-Targeted (TCP) and Non-Targeted (MCP) Microfinance Programs of the Small Enterprise Foundation, South Africa 60% 50% 40% Non client 30% TCP client 20% MCP client 10% 0% Poorest Less Poor Least Poor
Challenges to the Field and Solutions 67 CREATING VALUE FOR CLIENTS I guess fundamentally financial services are about clients, they are about people, because at root they are about helping people manage their lives. The financial services are designed to help the clients build assets and help clients move towards financial security or economic security. Frank DeGiovanni, Ford Foundation41As a social business, microfinance has at its core an intention to create benefitor value for its clients. This section examines in more detail how this intent canbe put into practice. Adapting Financial Services to Clients’ NeedsIn recent years there has been a move away from seeing microfinance as creditfor self-employment to recognizing the wide-ranging use and value of financialservices—savings, credit, insurance, and remittances. Access to relatively largesums of money compared to a client’s regular income gives that person themeans to better manage her or his finances, which can help in planning for andmeeting expected household needs such as paying for school fees or buying riceor maize in bulk. It also helps increase resilience and reduce vulnerability to themany risks that poor people face. In addition, financial services can help poorpeople take advantage of economic opportunities or invest in productive as-sets—for example, starting or growing a micro enterprise—and generate in-creased income that in turn increases access to basic necessities such as food,education, health, and shelter, and a general improvement in living standards. The availability of financial services in a market, though, does not neces-sarily mean that the services are well suited to the needs of clients or even thatthey are used. Provision of microfinance in agricultural communities is a goodexample of where the traditional product of weekly repayments does not meetthe needs of a rural producer for a big lump-sum loan at the beginning ofthe agricultural production cycle and repayment only after harvest time. AsdeGiovanni of the Ford Foundation states, “So if you were measuring it froma financial inclusion paradigm you would say, well, the services are there. Fromour point of view that product is not meeting the needs of that population. Theproduct needs to be retooled so that it’s adapted to the economic needs of arural producer.”42 A client focus reveals opportunities for improvements for most (if not all)organizations. Often small adjustments can have a big impact. At a recent micro-finance innovation conference,43 several studies suggested that small tweaks to
68 NEW PATHWAYS OUT OF POVERTYthe products offered by MFIs—such as allowing a grace period before repay-ment of a loan, offering loans in-kind rather than in cash, or providing very basicfinancial training—can dramatically improve outcomes for borrowers. Otherchanges to the delivering of financial services might include fitting in with theseasonality of client livelihoods, making services more accessible through mo-bile services, or building support between clients with the use of groups (see Box2.2): “Up to now, no one has progressed because of the repayment schedule ofone week. At least with one month (as a deadline) I could have gone all the wayto Bamako to buy merchandise and made a profit. It becomes harder during therainy season” (MFI client).44 While understanding of clients’ needs for diverse and flexible financial ser-vices has greatly improved, why is the industry still relatively undifferentiated,with the majority of MFIs providing a very limited range of services? One of thestrongest messages I hear repeatedly is the weakness of many MFIs in under-standing and responding to the needs of their clients (and potential clients). AsChris Dunford from Freedom From Hunger states, “A famous business adageis ‘know your customers’: the irony is that many MFIs, which try so hard to be Box 2.2 AMK Adaptations to Fit Rural Livelihoods AMK caters primarily to rural agricultural households, a market that is characterized by poor infrastructure and regular floods and droughts.An un- derstanding of client vulnerability and seasonality is therefore central to the design of products and services.AMK identified that many clients have nonfarm incomes, and that clients’ financial needs change throughout their lives as their lifestyles and income sources change.To address these needs AMK provides: Group loan products with complete flexibility of repayment: De- pending on their income stream, clients can choose between installment or end-of-term loans. Individual loan product that caters more to nonfarm opportunities: Individual loan products are also available for stronger clients. These include regular, business expansion, and seasonal loan products. Disaster mitigation products: These are emergency loans without col- lateral, which provides a flexible end-of-term repayment option. A microinsur- ance product is also under development. A range of savings products: These allow for readily accessible deposits and withdrawals or fixed deposits for clients who want to save their money for a specific purpose. Source: Adapted from Managing Social Performance:AMK (Cambodia),Imp-Act Consortium,and www.akm cambodia.com.
Challenges to the Field and Solutions 69businesses, aren’t following this adage and often neglect the needs and interestsof their clients.”45 In part, running an MFI is tough, and the margins are small. Much of theearly development of microfinance centered on replication of successful mod-els rather than seeking to understand client needs in each context. Lending tinyamounts of money is costly, so standardization of products and processes wasviewed as the only way to get the products to the population at a reasonablecost. Jeffrey Ashe of Oxfam America describes his experience in Bolivia in the1980s: “We assumed—a strange assumption—that the poor needed to save bytaking on debt. The mantra for us as institutions was to keep it simple, offer oneproduct, drive down cost, and expand the market. That had its own internallogic, but it didn’t meet the needs of clients.”46 From the late 1990s there was an increasing awareness of the need for amore client-led approach, and increasing focus on adaptation and diversifica-tion of products and services to fit a much more segmented client market. Al-though there are many examples of organizations that have a strong focus onunderstanding their clients and which continually seek new ways to create ad-ditional value, these organizations are a minority. Many MFIs, for example,continue to provide credit that is poorly adapted to the business needs of itsclients (see Box 2.3). One of the key messages of this chapter is the need for amuch greater application of what we know about how microfinance servicescan be tailored to the needs of different client segments. Key Areas for Development of Responsive Financial ServicesImproving credit products: Moving beyond credit for enterprise. Althoughmicrofinance has diversified significantly, many MFIs still implement a rigidcredit-for-enterprise approach that fails to adequately take into consideration Box 2.3 Examples of Poorly Adapted Credit • All members of a group take loans at the same time and for the same du- ration, meaning that loans are not available at the time when they are needed and may not fit with the business cycle of the clients’ enterprise. • Repayments must commence a week or two after disbursement, mean- ing that clients have not had a chance to invest the loan and generate a profit; clients often hold back part of the loan disbursed to make their early repayments.
70 NEW PATHWAYS OUT OF POVERTYthe complexity and needs of poor people’s financial portfolios, and does notallow flexibility where it is needed. While providing credit for investment in a business is an important mech-anism for raising the income and productive assets of clients, other unaddressedfinancial needs will lead to “misuse” of the loan—for example, paying schoolfees or coping with illness. In addition to enterprise investment, credit has an im-portant role to play in enabling improved financial management and respond-ing to crises—particularly where insufficient savings have been mobilized. The response of many that money is fungible and that loans should not betied to any purpose—the client knows best—is equally problematic, risking los-ing the opportunity to support clients in building a viable business and, if notcarefully managed, creating a risk of overindebtedness. Designing loan products. A central message is that the way in which loanproducts are designed is as important (if not more so) than the products avail-able. For example, Freedom From Hunger has been working on a more flexi-ble group lending product that allows clients to save in the group when they donot need to borrow and to borrow for the term, amount, and repayment sched-ule that makes sense for them. Not everyone in the group needs to borrow andpay back on the same schedule. Approximately 30% of group members at anyone time do not have a loan, but continue to save. These features are very muchappreciated by the clients, but, of course, it comes at the cost of increasing com-plexity of transactions and thus transaction costs for the MFI. The success ofthis approach is also reliant on strong group processes and ensuring that clientsare really empowered in decision-making processes. This again requires invest-ment of time by the MFI. Perhaps the most notable change in methodology toward greater respon-siveness to client needs is the experience of the Grameen Bank in its move toGrameen II methodology. Box 2.4 outlines how the organization has reengi-neered itself to better take account of the realities of the lives of its clients andtheir needs, with a much greater degree of flexibility and greatly improved sav-ings services. Improving access to savings and other financial services. Much of the em-phasis in microfinance has been on credit. Yet credit is debt and creates addi-tional risk for the clients and increases their vulnerability. We need to be realisticabout recognizing that microfinance cannot create benefits all the time, andwith credit in particular negative outcomes are inevitable some of the time.Credit can provide additional capital for larger demands, allowing expenditureto be brought forward or to make a productive investment, and therefore maybe worth the risk. Credit may also be important in responding to a need whereit would take too long to save sufficiently, or where cash is urgently needed.However, in many cases where the real need is for expenditure smoothing or to
Challenges to the Field and Solutions 71Box 2.4 From Grameen I to Grameen II “The way I look at Grameen II, even more so than when it was launched, is it’s trying to make it kind of client-friendly, or as Dr. Yunus said at the time, ‘take the tension out of microfinance’ and yet have a clear accountability, so that you can bear with the fact that sometimes things don’t go as planned.” —Alex Counts, Grameen FoundationaGrameen IThis system of delivering credit was one that involved poor women taking loansfrom Grameen and undertaking the responsibility of other group members incase of a default or delay. All group members took their loans at the same time,and repaid over a period of 52 weeks with a fixed weekly sum for repayment.However, the 1998 floods in Bangladesh made amply clear the “internal weak-nesses in the system,” as Yunus says.The main weakness was the rigidity in thelending scheme.The repayment for a fixed schedule was the same for everyoneand could not be altered: “Once a borrower fell from the track, she found it dif-ficult to move back on,” and this meant that opportunity for future loans wasendangered. Repayments began to decline sharply in 1998, and Grameen II wasin response to this, with its main “weapon” being greater flexibility.Grameen IIIn 2000 Grameen Bank initiated a major revamp of products and services withthe understanding that customers’ credit needs have been evolving and thatcredit alone is not sufficient to meet the needs of the poor. Among the mostimportant changes were those made to the products: • Mobilizing savings from the general public and not only Grameen customers. • Increased flexibility in savings products—no group savings products, flex- ible personal savings, commitment-based pension product, and so on. • Loan contracts were flexible with a wider range of products, variable terms, and repayment schedules. [Also included were] larger loans for business, a top-up loan facility, and introduction of rescheduling of loans in case clients are in difficulty.While the Centre Managers work closely with the clients and determine theproducts that they should have, as product knowledge is spreading Grameenmembers are increasingly gaining control of this aspect.The role of the manageris evolving from being a “teacher” to an “officer who supplies information andfinancial advice to clients who themselves determine the products and servicesthey require.”Source: Adapted from MicroSave Briefing Notes #1 and #8 on Grameen IINote: a. Personal correspondence.
72 NEW PATHWAYS OUT OF POVERTYcope with an unanticipated problem, other financial services may be more ap-propriate or complementary to credit. Savings are a low-risk way to better manage the resources that you have.While the appropriate balance between credit and other financial services maybe debated, clearly savings have an important role in meeting day-to-day fi-nancial needs and for coping with emergencies. Yet most institutional micro-finance focuses primarily on credit, with savings mostly confined to compulsorysavings that act as a substitute for collateral rather than serving a useful func-tion for clients. While the need for savings is understood, a tension exists be-tween our understanding of client needs and the services MFIs are able to offer.Savings are more tightly regulated and less profitable for MFIs, so significantchallenges arise when providing access to this service (see Box 2.5). In addition to savings and credit, other financial services such as insuranceand remittances are also important tools for poor people’s financial manage-ment. Insurance when well structured can help clients cope with emergencieswithout damaging their livelihoods, and remittances are a crucial lifeline formillions of the world’s poor. Again, access to these services alone is insufficient,and attention needs to turn to their design and delivery to create value. Women’sWorld Banking, for example, highlights how microinsurance can be designedwith the specific needs of poor women in mind. Poor women have traditionally Box 2.5 The Experience of Cashpor, India in Mobilizing Savings In India, MFIs are not allowed to raise public deposits, so in order for en- tities like Cashpor to facilitate saving services they have to be listed as a “busi- ness correspondent” of a bank, whereby the MFI acts as the bank’s agent, representing the bank’s products and services to the customers in exchange for a small fee. Cashpor is strongly of the view (corroborated by the market research that Grameen Foundation has undertaken) that there will be a good demand for “commitment” saving products with doorstep service, given customer prefer- ences and their income flow patterns. As of now, Cashpor has not started of- fering the saving service but is in discussion with various banks. However, as a banking correspondent, Cashpor does not have the freedom to independently develop its products, except that it can influence decisions of the bank. Source: Santosh Daniel, Grameen Foundation (working with Cashpor to support development of sav- ings products)a Note: a. Personal correspondence.
Challenges to the Field and Solutions 73managed risk in very risky ways: by relying on their husbands, pulling childrenout of school to work, or selling productive assets such as livestock or equip-ment. Gender-sensitive microinsurance might cover ill heath due to maternityor childbirth, or give women the choice of selecting another beneficiary if theydo not think their husbands will protect the children properly after the woman’sdeath. In Colombia, one company’s life insurance pays monthly benefits thatcan be used for the purpose of educating the children for two years after thedeath of a parent, in order to reduce the pressure on the surviving parent topull children out of school.47 Community-based savings and loans. In most communities, informal savingsand credit groups exist that serve as an important tool for financial manage-ment. Groups focus on building up relatively small amounts of savings that canbe lent out to the group, and help people manage anticipated and emergencyneeds for money. A number of organizations have developed community-basedmodels of microfinance that build on traditional savings and credit groups. Thegroups, when they are properly trained, build in flexibility; the loans are smallenough for the clients not to get into trouble, and all the profits return to themembers as each member builds his or her own savings account. While savings groups are generally supportive and loan terms are flexible,savings are locked in for a predetermined cycle, rather than accessible whenneeded. Interest is paid back to members (rather than covering the costs of anMFI), but stronger members often become net savers (and, on balance, benefit)and weaker members become net borrowers (and, on balance, pay interest). Inaddition, as the money is shared out among the group annually, the groups donot build up money over time, and thus are not terribly good at building upsufficient capital for investment in enterprises or longer-term needs for life cycleevents such as weddings or funerals. Lauren Hendricks of CARE reports, “Inmy experience, mature VSLA groups frequently start to request additional, moreformal financial services in order to meet some of the shortcomings of savings-led groups.”48 This creates an opportunity to build linkages between thesegroups and other financial institutions. For example, in India the self-help grouplinkage program provides capital from banks to self-help groups that meet cri-teria demonstrating the viability of their financial systems. The strengths of community-based microfinance in mobilizing savings andproviding an institutional model that does not push credit clearly represent oneaspect of the solution to the challenges in microfinance. Somehow, we have tocapitalize on the good of encouraging savings and self-management while in-creasing flexible access to these savings. Thus, it would seem that both the creditand savings-led approaches have strengths and weaknesses when analyzed froma client perspective, and lessons result from both models.
74 NEW PATHWAYS OUT OF POVERTY Some models seem to fuse the strengths of each approach. The originalmethodology for Village Banking, for example, used extensively in Latin America,included the establishment of an internal savings fund that could be used tomeet anticipated and unanticipated needs through loans to group members.This approach complemented the larger working capital loans that the micro-finance organization provided. While this plan seems to provide an ideal com-bination of financial services, the internal fund was gradually withdrawn bymost MFIs as it was seen to be costly to facilitate and competed with the MFI’sexternal loans and therefore undermined the MFI’s financial sustainability. SomeMFIs such as Finca Peru have retained this internal fund (see Box 2.6). Guy Vanmeenen of CRS cautions, however, against overoptimism in theselinkages, and highlights the value of giving people access to a range of different Box 2.6 TheValue of the Internal Savings Fund (Finca Peru) Finca Peru includes compulsory savings, which act as security for the MFI. There is also an internal group savings account.As of February 28, 2011, Finca’s loan portfolio was US$3,920,804, while member savings were US$4,064,987. From the savings around 70% is lent as internal account loans. Iris Lanao Flores, executive director, describes the internal account as a complement to the Finca business loans. Internal fund loans are flexible, with members choosing the num- ber and regularity of installments, and can be used for any purpose, allowing members to better overcome emergencies, improve housing conditions, and ed- ucate their children. Interest rates for internal and Finca loans are the same, al- though at the end of their loan cycle internal interest is paid as dividends relative to the amount of savings each member has. There are financial pressures on Finca Peru in maintaining the internal fund, however. The institution’s staff track the groups’ internal savings and loans, a costly undertaking for around 16,000 clients. Field staff manage their own port- folios as well as supporting the solidarity groups to manage their internal funds, and as Flores says, having both Finca Peru loans and group loans available means “we don’t need outside competition, we have it within.” Flores does not see this as a disadvantage—quite the opposite:“The costs are very high but . . . we have been self-sufficient both operationally and finan- cially since 1998. ROE is more than 10% so we can invest on expansion in the most remote rural areas in the poorest areas of the country. During our life- time, we have stubbornly maintained our methodology for empowerment, using microfinance as a tool.” Source: Iris Lanao Flores, executive director, Finca Peru
Challenges to the Field and Solutions 75services, rather than trying to provide for all needs in one model: “Financial in-clusion is about having as many different types of products and services as pos-sible to everyone in rural areas, to the poor. One of the dangers is that . . . peoplesay, can we do more, can we add on more, can we make it more than it is? Wehave to be humble and be clear on what the limitations of this are. You don’tnecessarily have to address the limitations.”49 Adding Value Through Nonfinancial Services The basic spirit of microfinance is to search for possibilities based on knowledge, understanding, and perspectives that start at the ground level. We understand our clients and their needs. There is no reason why we cannot use those same skills to address the other constraints our clients face. Fazle Abed, BRAC50There is much debate about whether MFIs should or should not provide non-financial services. Some MFIs recognize the true potential of microfinance as onlybeing realized when the opportunities to link or integrate a wider range of servicesare taken. BRAC, one of the world’s largest NGOs, typifies this logic: “In BRACwe saw that many women were stuck in low-return activities. We saw that manywere involved in poultry but were not making much money because of diseases.So we trained a person in each village organization to do vaccinations, treat basicdiseases, and train in proper feeding and hygiene. These people get paid for theservices they provide to the women who raise chickens” (Fazel Abed, BRAC).51 Others argue that MFIs should focus on the things they do best—deliver-ing financial services—and concentrate on improving them. Carlos Danel ex-plains the approach of Compartamos: “As an institution, we realize that otherservices are important and that microfinance is not a panacea. Other services areneeded to drastically change lives of people below the poverty line. But these wecannot do.”52 Clearly there will always be opportunities to do more to createsocial value for clients, and there must be a balance struck between undertak-ing additional activities for social reasons and the viability of the business. Yet,it is not a question of whether an MFI chooses to provide financial services, buta practical question of their capacity to respond to clients’ needs. There may beopportunities or limitations to providing both financial and nonfinancial services. The infrastructure of microfinance with outreach to millions of people,often with regular meetings, creates a huge potential to add value: integratingor partnering to create access to nonfinancial services such as financial educa-tion, business training, health education, or legal and rights-based services. By
76 NEW PATHWAYS OUT OF POVERTYstarting with an understanding of the client and her needs it becomes clear hownonfinancial services can complement financial services and create benefits forclients and MFIs: • Investment in an economic opportunity and productive assets. While an appropriate loan might be important for a microenterprise, it may be that business training, marketing, or access to high-value products would in- crease the likelihood of success in terms of growth and profitability. A supportive group might also be an important contributor. • Managing for anticipated financial needs. A range of affordable and ac- cessible savings and credit products may assist clients in meeting their needs, but financial literacy training might enhance outcomes. • Coping with emergencies. Similarly, while savings, insurance, or emer- gency loans may help reduce client vulnerability to emergencies, other in- puts could also reduce the likelihood of problems, such as facilitating access to health services and establishing well-formed and facilitated groups that are likely to support one another in times of crisis. • Other social benefits. Other outcomes pursued by many MFIs—such as women’s empowerment and improvements in health, housing, or educa- tion—are all much more likely to be achieved through a combination of financial and nonfinancial services. Groups, for example, have the po- tential to create benefits such as increased confidence, strengthening of social relationships (in the family and community), and empowerment. These outcomes are mediated by the nature of specific groups, and de- pend to a large degree on the relationship with MFI field staff. Micro- finance can also help right power inequalities between women and men, but not without “a clear commitment and strategic approach to ensuring that it does.”53 These might include awareness, literacy, and related skills development or strategies to affect men’s behavior toward women within the household and local community. Business Models for Combining Financial and Nonfinancial ServicesIn some cases—such as the BRAC example—a social business model may beable to sustainably deliver nonfinancial services. In others, some nonfinancialservices may be integrated into financial services. Many organizations, for ex-ample, provide support such as business skills training, marketing, or provision ofhigh-value products. In Tunisia enda inter-arabe, for example, includes business
Challenges to the Field and Solutions 77 Box 2.7 Freedom From Hunger: Meeting Client Needs to Avoid Loan Dispersion In giving loans intended for businesses which are in fact used by clients on a variety of other pressing needs, MFIs risk potentially overindebting their clients.The issue, however, is not one of clients using the loans “incorrectly,” but of MFIs not adequately meeting client needs. Freedom From Hunger has been working with a number of MFIs to address this issue, particularly in relation to use of loans for health needs. Though there are a large number of reasons for clients to default or drop out, one of the most common is ill health, either of the client or family mem- bers. Sickness impacts those living in poverty particularly hard.A recent study in Ghana indicated that the cost of malaria treatment represented just 1% of wealthy families’ income but 34% of poor households’.a The natural response one would think when faced with such pressures is for households to divert loans intended for other uses—microenterprise, for example—to urgent health expenses. This is corroborated by research carried out by Freedom From Hunger at five MFIs, which revealed that large proportions of clients resort to using business loans for health-care expenses, ranging from 11% of clients at RCPB in Burkina Faso to 48% at Bandham in India.b Freedom From Hunger has shown that providing clients with appropriate “microfinance plus” health services potentially allows clients to meet their health needs as required, enabling clients to be more successful—less likely to default and drop out—and the MFI to benefit not only from meeting its social mission, but from improvements to its bottom line. In addition to “impressive net social value creation,” the research concluded that the combined products make good business sense. Health protection prod- ucts tested included health education, health savings, health loans, health micro insurance, linkages to health providers, and the sale of health products in rural communities. Some of these products are expected to break even and even begin earning net profits in coming years, and other non-revenue-generating products (such as education) may soon cost less due to economies of scale. Notes: a. M. Reinsch, C. Dunford, and M. Metcalfe,“The Business Case for Adding Health Protection to Microfinance,” Freedom From Hunger, June 2010, 3. b. A. Kobishyn, “Opening the Black Box: How the Poor Use Credit in India,” Microfinance Insights 12 (May/June 2009).development services as a core product: “We have information and discussion‘circles’ (on a wide range of subjects about business and social matters). . . .This contributes to an atmosphere of confidence among the clients and assiststhem in using their loans wisely.”54
78 NEW PATHWAYS OUT OF POVERTY Other MFIs may decide that they do not have the capacity to diversify be-yond financial services, and they seek partnerships or linkages with other or-ganizations to deliver services that create synergies with their financial services.TRIAS, a Belgium MFI, works in this way: “We start at the level of organizedfarmers, and we analyze their needs with them, then we look for a partner mixwho can guarantee these services. This can be the MFI itself or another actor”(John Blieck, TRIAS).55 Listening to Clients What separates legitimate microfinance is our interest in continuous improvement to meet client needs. We sometimes err, but we should al- ways learn and improve. Being honest about our mistakes and opening ourselves to criticism is part of the process. Davis Broach, Relief International56A characteristic of successful client-focused organizations is regular feedbackfrom and dialogue with clients (see Boxes 2.8 and 2.9). For example, enda inter-arabe integrates discussion circles into its methodology, holding regular groupdiscussions on a wide range of subjects about business but also about social mat-ters, as well as client and exit surveys: “For us, listening to clients and improvingour products, as well as introducing new products, comes naturally” (MichaelCracknell, enda inter-arabe).57 MicroSave has been a strong advocate for client-led microfinance and pro-vides numerous case studies of how learning from clients drives improvementsthat benefit the clients and the financial performance of the organization. Ser-vices better meet clients’ needs, and clients are less likely to take inappropriate Box 2.8 Integrating Client Feedbacka Over the last decade, Opportunity International has conducted more than 50,000 face-to-face surveys with clients in Africa,Asia, Eastern Europe, and Latin America.The research showed that clients want savings as much as they want small business loans, and their input has aided the development of a wide array of financial tools—including agricultural finance and rural savings, crop and health insurance, school fee loans, and savings accounts—to improve the stan- dard of their lives while they work their way out of poverty. Note: a. Personal correspondence from Opportunity Director
Challenges to the Field and Solutions 79 Box 2.9 Compartamos—Adapting Financial Products to Client Needsa When researching its life insurance product, Compartamos discovered that when a family loses a bread earner, negative family cash flow typically takes about 1.8 years to recover.This included not only loss of income, but also the expense associated with the funeral.There are limited possibilities to raise funds quickly so an immediate loan is usually sourced from a moneylender or pawn shop, making the cost even higher. Compartamos designed a low-cost life in- surance product, but it was difficult to sell because of people’s unwillingness to pay for a future event. So in focus groups they asked clients what would be more appealing: lower the interest rate on their loan or build in life insurance (for US$1,250—an amount identified in the initial research to cushion the shock) and overwhelmingly they chose the life insurance option, and some vol- untarily paid an increased premium. Note: a. Personal correspondence from Carlos Danel, Compartamos.loans and become overindebted. The MFIs also experience increased growth,improved client satisfaction, and fewer problems. The potential market for ser-vices is also increased as MFIs are able to reach people in the agricultural sec-tor, more remote areas, or simply those who do not need an enterprise loan. When listening to clients, organizations must be careful to think aboutwhose voices they are hearing. Women and men often have different needs; vul-nerable clients are less likely to participate in focus group discussions. The point is highlighted by a client feedback survey at AMK in which 11%of clients raised problems with “small loan sizes.” The fact that AMK’s loan sizeis indeed the smallest in the local market led management to wonder whetherthe loans were becoming too small to fit the needs of clients. Segmentation ofthe data by the clients’ poverty level demonstrated that poorer clients were notcomplaining. As a result, group loan sizes were maintained at the same level,with individual larger loans for better-off clients (see Figure 2.2). Balance and FlexibilityMFIs face constraints in terms of capacity, population density, infrastructure,and regulation, all of which determine what changes are possible for each or-ganization. A balance is important; rapid product diversification, or changes toproducts, can be as dangerous to clients and the institution as rapid growth andexpansion.
80 NEW PATHWAYS OUT OF POVERTYFigure 2.2 AMK Client Satisfaction Data Segmented by Client Poverty Level10% Poorer (n = 130) 5% Medium (n = 110) Better off (n = 49) 0% Small loan sizeSource: SPM in Practice: AMK (Cambodia), Imp-Act Consortium, 2008, www.Imp-Act.org. A focus on building clients rather than building institutions enables an or-ganization to identify opportunities for change. It is a journey, a process of con-tinuous learning and improvement, and MFIs can do many relatively smallthings to improve their services and create more value for their clients. As a firststep, it is about ensuring that services are accessible, timed to fit with people’sneeds, and above all do not have negative impacts. Even where an MFI understands what clients need, there may be internalprejudice and resistance, making change harder to achieve. When GrameenBank changed to a new operating system that allows clients greater flexibilityto reschedule loans, motivated by an understanding of the impact of emergen-cies such as illness and natural disasters on clients’ ability to repay, the changeprovoked strong reactions from staff convinced that this level of flexibilitywould lead to the breakdown of group solidarity and widespread repaymentproblems.58 This sort of resistance may help explain the relative lack of progressin building more client-focused MFIs. It is perhaps worthwhile to end this section with a note of caution from arespondent to my survey for this chapter: “If MFIs started with the premise ofat least doing what they set out to do well, then perhaps they could explorebroader areas. But currently, given that the vast majority cannot even offer afairly priced and efficient loan to clients for productive purposes in a sustain-able manner, perhaps this should be a priority. Learn to walk before running”(anonymous).
Challenges to the Field and Solutions 81 PROTECTING CLIENTS FROM HARM: RECOGNIZING CLIENT RISK AND VULNERABILITY IN REGULATION, GOVERNANCE, AND SYSTEMS TO PROTECT CLIENTS This is a scary moment for the industry with its root cause being insuf- ficient systems for tracking client indebtedness, unfettered competition, irrational growth expectations, and little analysis and understanding of the client’s ability to repay. Siddhartha Chowdhury, ACCION International country manager, India59It is important to recognize that, as well as creating value, microfinance also hasthe potential to harm its clients. This section focuses on how MFIs design theirproducts, services, and systems based on a recognition that illness and otheremergencies are commonplace in the lives of poor people. By protecting andhelping clients come through these problems, MFIs can significantly improve thechances of achieving significant positive changes in the lives of their clients. Responsible FinanceThe profits that some microfinance organizations and their investors are mak-ing, combined with the experience of client overindebtedness and coercive col-lection practices, has led to a lot of debate about responsible finance. From aclient perspective, a number of key elements can be defined. These are reflectedin the client protection principles promoted by the SMART Campaign, an in-dustrywide initiative supported by over 1,000 MFIs.60 In this section I highlightthe vulnerability of microfinance clients and the risks that credit in particularcreates, and focus on three key elements of responsible finance reflected in theseprinciples: • Avoiding overindebtedness • Appropriate collections practices • Transparent and responsible pricing Avoiding Overindebtedness A few months ago I was in Nicaragua visiting a branch office of a local nonprofit MFI. The offices were stuffed with a crazy assortment of
82 NEW PATHWAYS OUT OF POVERTY household appliances. Loan officers’ desks were wedged between re- frigerators and stacks of radios and microwave ovens. It turned out this was all the stuff the “pro-poor nonprofit” organization had taken from the homes of the poor. Aaron Ausland61For clients, overindebtedness reflects the risk of credit and relates to an experienceof someone who is “continuously struggling to meet repayment deadlines and re-peatedly has to make undue sacrifices to meet his obligations.”62 While this def-inition makes intuitive sense it raises a host of questions, such as, “If a clientchooses to take a loan knowing that she will have to make significant sacrificesto make her obligations, should the MFI have not granted her loan?” For exam-ple, microfinance clients I interviewed in Haiti sacrificed food purchases to makeloan repayments, with the knowledge that their investment in a business wouldgenerate future profits and improve their well-being in the longer term. From an MFI perspective, overindebtedness translates into client delin-quency is measured by portfolio at risk (PAR). But from a client perspectivethere is often great stress that is not translated into repayment problems. PARis a very insensitive indicator, and is also driven by many factors. A high port-folio at risk may help an MFI recognize that it has a problem with overindebt-edness, but it does little to help an MFI recognize in advance when the problemis occurring. For group lending in particular, PAR is usually only captured whena group fails to complete a payment rather than when an individual within thegroup fails; thus, default only rises when clients are very highly stressed. InIndia, for example, low PARs are used to argue against overindebtedness in thecurrent competitive context. While multiple loans are often seen as an indicator of overindebtednessfrom a client perspective, these loans may be very logical when the clients’ needsare not being served by any one institution. Bobbi Gray of Freedom FromHunger writers, “A client can appear overindebted with the one loan they haveand then there are those who have five loans, and they’ll indicate they are all fordifferent purposes and they are just proud they are not having to borrow fromfriends or family.”63 Access to formal financial services may also lead to unex-pected outcomes, with access to a loan from an MFI increasing people’s credit-worthiness and therefore leading to increased borrowing from moneylenders.64This example serves to demonstrate the complexity of informal financial mar-kets and people’s livelihoods. Overindebtedness is created where responsible lending goes wrong, or by ir-responsible lending where one or more MFIs provide loans that exceed a client’scapacity to repay without significant sacrifice. Four elements are key in avoid-ing overindebtedness:
Challenges to the Field and Solutions 83 • Structuring products and services to ensure that they are appropriate for their purpose and cash flow. • Building in measures to help clients cope with emergencies when they occur. • Responsible lending that assesses capacity to repay and does not push credit or mis-sell other products. • Supporting clients via financial education helps them to understand the risks and obligations related to borrowing. The first step in avoiding overindebtedness is to ensure that products andservices are well suited to client needs. As discussed in the section on client value,financial services have an important role to play in helping people reduce theirvulnerability and manage risk. Credit needs to be designed with this in mind,and poorly structured it can serve to increase risk and vulnerability rather thanreduce it. Savings, insurance, and remittances are all important managementtools that can be useful when things go wrong. Good client feedback mechanisms are important practically for MFIs to en-sure that clients receive appropriate loans and that information comes back tothe MFI if problems are encountered. As previously discussed, there is a com-mon mismatch between theory and reality, with MFIs lending on the assump-tion that a loan is productively invested in a business, even when this is notoccurring. The story in Box 2.10 illustrates how easily clients can get into acycle of debt where the availability of repeat loans can create a cycle of bor-rowing that does not necessarily benefit the clients. Another source of overindebtedness is inappropriate or excessive lending byMFIs. This situation arises when insufficient checks are made on a client’s ca-pacity to pay, or when multiple lending makes these checks ineffective. Assessing capacity to repay. A number of people I interviewed highlighted theimportance of MFIs having some form of assessment of capacity to repay (seeBoxe 2.11). Individual lenders, particularly those lending to businesses, oftenconduct interviews with individual clients to assess their business strength, assets,income sources, or cash flow. However, this approach is time-consuming and re-quires skills on behalf of field staff. These steps are thus more suited to individuallenders working with relatively high-value loans. Similarly the use of credit bu-reaus has significant information requirements and may be costly for the MFI ordifficult to establish in many markets, due to a lack of client identity documentsand other formal information that may make the system difficult to operate. Group screening. Most group-based lenders rely on peer screening to assesscapacity to repay. Where MFI staff are not able to do effective assessment of
84 NEW PATHWAYS OUT OF POVERTY Box 2.10 The Cycle of Debt and Borrowing “I was visiting an MFI where in addition to their group loans, clients were per- mitted to take complementary loans. Of a group of 20 to 22 women, 14 of them had these individual complementary loans and they were all due at the meeting I was attending.The MFI had decided to slow down the comple- mentary loan program because PAR was rising. “When they were informed that they could not get new loans on that day, suddenly no one had the money for their payments—even though min- utes before everybody had nodded yes that they have their payments.After much heated discussion, it became clear that many of the women had sim- ply borrowed the money that they needed for repayment from another source, planning to get a new loan and repay the person they borrowed from on the same day.When they learned there would be no more loans, it was as if the music had stopped during musical chairs and everyone was left without a seat. It was an extraordinary thing to watch.” Lisa Khun-Fraioli, Freedom From Hungera Note: a. Personal correspondence.client capacity, then it is important for the MFI to take active measures to buildclient understanding, group control, and responsibility for the lending process.Solidarity groups, for example, must verify that other client loans are affordableand commit to covering their repayments in the case of default. Lisa KuhnFraioli describes the experience of Freedom From Hunger, which emphasizes astrong client-led evaluation process as a critical part of group lending: “Whengroups are formed, clients are taught a simple evaluation methodology to assessinvestment opportunities, capacity to pay, and risks. This is usually comple-mented with ongoing financial education that teaches clients about budgetingand estimating their capacity for indebtedness.”65 However, in reality many organizations have reduced the role of solidarityin their group lending, and effectively are lending to individuals within groups,using security such as high compulsory savings or in some cases collateral inplace of joint liability. Screening by clients is often ineffective, with peer pres-sure affecting loan sizes that are approved. Thus, this area is a particular chal-lenge for group lenders, where detailed individual assessments are not possiblegiven the productivity levels of field staff. Mis-selling. With increasing concern over interest rates, MFIs are seekingother ways to generate profit. A narrow focus on profitability and limited client
Challenges to the Field and Solutions 85 Box 2.11 Credit Assessment at Swadhaar Swadhaar (India) uses a two-part evaluation to determine whether to lend and the amount to lend a prospective client. First, the loan officer (LO) deter- mines whether to underwrite the loan based on whether a group is willing to take the responsibility of its members. Second, an LO estimates a client’s ca- pacity to pay based on sources of income, by asking a series of questions dur- ing the group meeting itself. For business clients, LOs evaluate and crosscheck sales, and for salaried clients, LOs verify the stability and amount of income by doing an employer reference check. LOs use a loan matrix to determine re- payment capacity based on the client’s income.This loan matrix takes into ac- count a client’s historical repayment behavior, as well as feedback from other clients and field staff. To check overindebtedness of its clients, Swadhaar captures data on its clients’ borrowings and has signed up with a credit bureau to track a client’s credit history with other microfinance institutions. Swadhaar also conducts financial education, covering topics such as budg- eting, managing cash flows for emergencies, and large planned expenditures. Source: Shweta Pereira, chief manager, credit and riska Note: a. Personal correspondence.focus can lead to the pushing of inappropriate products and mis-selling of otherfinancial services. Many organizations, for example, bundle credit life insur-ance with their loan products. This purports to be a benefit for clients, but pri-marily serves to protect the MFI from default by paying off the client’s loan tothe MFI; premiums are often excessively high. The recently launched Social Per-formance Indicators for micro insurance go some way to address this.66 Responsibility to avoid overindebtedness also lies with clients. Given thelow levels of education and financial literacy of microfinance clients, MFIs havea responsibility to ensure that clients fully understand the risks and obligationsof credit. Clients should also be well informed about the service that they shouldexpect, or field staff can take shortcuts or push inappropriate loans or otherproducts. The following quotes from clients of a Bolivian microfinance institu-tion, CRECER, further underscore this point. “My children became CRECER borrowers when they moved to town, but[taking out a loan] is not for everyone because some don’t know how to usemoney and so it gets them into trouble,” said Juana, age 53. Julia, age 46, in-dicated that “taking out a larger loan to me means success, but more debt alsodepends on if you manage your money well.” Elsa, age 59, shared, “If you need
86 NEW PATHWAYS OUT OF POVERTYmoney, CRECER is good. But you must also know how to administer themoney well or it can be bad.”67 Opportunity International, for example, an international organizationworking in more than 20 countries, sees investment in financial literacy as acritical component: “Clients are better empowered to make informed financialdecisions and to exercise those decisions with confidence.”68 When Things Go Wrong Zero delinquencies have always concerned me because that’s not quite how the world works. Businesses are sometimes unable to generate the cash flow to make a payment. Given that we know that that’s the case, if people are making payments, how is that happening? Who’s actually paying for these businesses? What are they drawing down? What pres- sures are being brought to bear? Alex Counts, Grameen Foundation69Even if an MFI takes care not to overindebt its clients, things can go wrong forclients, and their debt can become burdensome. One of the defining features ofpoverty is the inability of poor people to cope with the inevitable problems that lifethrows at them. Increasing emphasis on savings and, to a much more limited ex-tent, insurance and remittances builds client resilience and provides the means torespond when things go wrong. However, credit leaves clients in debt, and the wayin which MFIs respond to this vulnerability in the services they offer and in delin-quency management makes a huge difference to their social outcomes. These is-sues are critical considerations for MFIs that seek to be responsible lenders.Contractual Obligation or Flexibility?Striking the right balance between a client’s contractual obligation—and the fi-nancial viability of an MFI—and a need to protect clients from harm is a criti-cal point. Many MFIs take a zero-tolerance approach to delinquency, arguing,for example, “The practice of banks and MFIs realizing security in the devel-oping world happens for the same reasons that banks pursue these remedies inthe developed world—to contain credit losses and to maintain a sense of com-mitment and discipline in their borrowers.”70 Microfinance, however, is not the same as formal-sector banking. Clientsare more vulnerable and less financially literate, and the information availableto assess capacity to repay (credit bureau, employer reference, and so on) is farless reliable in the informal sector. In addition, most MFIs work in contextswhere the social safety nets such as those in Europe or the US are not present.
Challenges to the Field and Solutions 87It is impossible for MFIs to assess risk to the same extent as formal banks; there-fore, it is important that responses to genuine client problems are more flexible.However, many MFIs have rigid systems that do not take into account clients’vulnerability. When things go wrong for clients there is no flexibility on the partof the MFI. Without resources to draw on, clients have to resort to selling as-sets or borrowing money from money lenders to repay. When I fell seriously ill (due to pregnancy) and the medical bill came up to 25,000 FCFA, I got a loan in the amount of 70,000 FCFA. After the second reimbursement, however, I could no more keep up with those re- imbursements. I therefore asked the program officials to offer me a grace period so that I could pay my debt off. But they refused, arguing that other women might do the same thing in order to escape the weekly reimbursements. When he heard about the situation, my hus- band managed to find the amount remaining to be paid and then asked me not to participate anymore. He thought that the program is not meant to protect people from shame; rather the opposite.71 The line is often very fine between a response that resolves issues, helpingclients recover and remain with the MFI, and one that may succeed in achiev-ing repayment but leaves the client worse off. Credit programs that apply zerotolerance with little flexibility risk harming their clients. Most MFIs see delin-quency management as being critical to success, and send out a strong messageto staff that late payment should not be tolerated. This approach is supportedby incentive schemes that often drastically cut payouts to staff should the port-folio at risk rise above quite a low level (see Box 2.12). Box 2.12 Branch Accountant in MFI Branch, India Zero PAR is the most important criterion on which our branch is judged, and that is why all/most of our branch staff go to any defaulting/potential defaulter’s house on the same day and try and get the payment.To us, Zero PAR is simply about ensuring 100% on-time repayments always, and if we cannot get it from clients, we have to make over the delinquent payment from our resources and then recover from clients. Our institution will not accept anything less than 100% on-time repayment, and our incentives are tied to not only loan disbursement but also 100% on-time recovery. Source: Ramesh S. Arunachalam, Microfinance India blog, December 27, 2010, www.microfinance-in- india.blogspot.com
88 NEW PATHWAYS OUT OF POVERTYCovering Up Problems in GroupsThis issue is particularly common in group lending where group solidaritymasks problems and high repayment rates can be achieved despite severe neg-ative experiences by individual clients. Clearly, it is important to recognize that the group mechanism is very frag-ile and that many MFIs quite rightly fear that the whole group or many groupswill stop paying if the MFIs start granting some clients tolerance. This very realrisk has to be managed as an MFI seeks to find a more compassionate solution.CARD in the Philippines, an MFI with over a million clients, has successfullymoved away from a zero-tolerance approach. Annie Alip of CARD explains,“We held dialogues, branch by branch, with those who were having repaymentdifficulties, and came to agreements with the most convenient way for them torepay. Surprisingly, many came to these dialogues, proving that many clientswere not willful defaulters; it was just life happened, they were vulnerable andthey did not have safety nets.”72 Appropriate Collections Practices The pressures on me are so high and it is impossible to move at the very fast pace of growth all the time. I worry what will happen if peo- ple do not pay back loans as I know their income stream is weak and unpredictable. Indian MFI branch manager73While the need to ensure repayment and low portfolio at risk is core to the suc-cess of microfinance as a business, care needs to be taken not to incentivize staffor clients to use coercive methods to collect repayments. It is also essential torecognize that when things go wrong in the lives of clients, and they are undersevere financial strain with none of the safety nets common in the Westernworld, applying strong pressure to repay can be damaging.Avoiding Coercive Behavior by StaffThere was strong support among practitioners I consulted for the assertion thatdeterioration of relationships between staff and clients in many organizationsis leading to a mismatch between client needs and services delivered, poor com-munication and transparency, and inappropriate collection practices by staff. Pressure on staff to ensure high repayment rates often creates an overbear-ing or coercive approach from field staff—often male staff and female clients(see Figure 2.3). In the worst cases we see MFIs that achieve a 100% repay-ment rate through practices such as holding clients in a meeting until all moneyhas been collected; clients with repayment problems leave the meeting to “find”