Money Talk: Microfinance as a Means of Reaching People who are Poor by Stan Parish
My friends joined the group after learning from me. They started their own shops. They are sending their children to school now, and they have postponed the marriage of their children from 18 years to 21 years.
So says Ms. Primelan of Nathamalaituhur Village in rural South India, a beneficiary of microfinance and one if its successes.
Microfinance began 30 years ago as an experiment in a marketplace in rural Bangladesh. It has since become a financially viable industry with a global repayment rate of 97 percent and astonishing annual growth.
The essence of microfinance is a practical and philosophical inversion of traditional financial services. Rather than lending to established corporations, microfinance institutions actively seek borrowers who are poor.
The majority of borrowers are women, and the loans usually are not made to individuals. Because physical collateral is often unavailable, social capital is leveraged within a group of borrowers to create a joint liability self-help group and ensure that the loan is repaid. Loans as small as the equivalent of $100 USD have allowed aspiring entrepreneurs to escape the poverty cycle.
With all the attention that microfinance receives, it is important to remember that it is a means to an end and not the end itself.
Problems of communication are endemic in the industry, dating back to what could be considered the first micro-loan. In 1976, Muhammad Yunus, a young economics professor at Chittagong University, Bangladesh, took his students into a small village where he discovered a woman crafting beautiful stools out of bamboo. He inquired what the woman earned for her work after repaying the trader from whom she borrowed. She told him she earned the equivalent of 2 cents in net profit. Yunus was appalled. He wanted to help her find a means of financing that would allow her to make more net profit.
But, first, Yunus had an enormous communication barrier to overcome. "That was a time in Bangladesh when women didn't touch money and didn't talk to men," explains Sam Daley-Harris, director of the Microcredit Summit Campaign, an important facilitator of dialogue in the industry. "Yunus had to have a female student ask the woman a question, then return to tell him the answer. There were barriers of communication even in explaining the value proposition."
What Yunus proposed was a small loan out of his own pocket to a group of women in the village. The women would then pay back the loan collectively from their individual businesses, increasing their line of credit as they did so. That model of lending model prevails in the industry today.
In 1983, Yunus founded Grameen Bank, which provides credit to small groups of women to raise them above subsistence. Since its inception, Grameen has disbursed $5.59 billion in loans with a total recovery rate of 98.49 percent. Of its 6.39 million borrowers, 96 percent are women. The Grameen model of joint liability lending has been replicated countless times across the globe. Microfinance has gone from an informal collective of open-market vendors to an industry that reaches 92,270,289 clients, according to the Microcredit Summit Campaign Report of 2005.
The difficulty of discussing microfinance with people connected to the industry is that nearly all of them have a vested interest in making the industry look good. "Be careful talking to them," someone warned me when I told him I was speaking to the head of a major non-profit microfinance network. "Donor funds butter their bread."
While articles about microfinance provide a goldmine of anecdotal successes"nearly every article on the subject begins with the touching story of a borrower in a far-away land who made a big success"the news is not all good. Selective anecdotal evidence may be precisely the problem; there is a temptation to play up the social impact story and soft-sell the risks. A woman who rose out of poverty with an entrepreneurial sprit and a small loan makes a better headline than a recent default. While microfinance is a valuable tool in the fight against poverty, it has its limitations.
Access to credit and financial services are not a panacea for the ailments of the developing world. "It's a band-aid solution," says Reuben Abraham, director of Cornell's Bottom of the Pyramid Learning Lab in India. "It's the classic case of a symptom being diagnosed as a disease. The disease is poverty."
There are statistics which link microfinance to improvements in everything from nutrition and education to AIDS prevention and gender equality. While microfinance clearly has a transformative power in the communities where it has taken hold, the macro effects are much harder to assess. There is a heated discussion within the industry about the cost and the competency of measuring social impact beyond the shining examples. But the goal of microfinance is poverty alleviation, and the true success stories are the ones in which poverty and all its accompanying ailments are eliminated.
The story of Ms. Primelan of Nathamalaituhur Village in rural southern India is a microfinance success story. A struggling beautician, she took a working capital loan and opened a shop that she turned into a successful business. She became a social service consultant within her self-help group and is able to help improve the lives of her family as well as others in her community.
Hers is the kind of story that appears in the sidebars of industry literature, accompanied by a photo of a woman standing proudly in front of her store. The most compelling part, however, is its epilogue
After establishing her business and helping her community, Primelan experienced a shift in priorities almost unheard of for a woman in her position. "I was more interested in my own development," she explains. "I finished my aroma therapy training. I also finished my master of arts degree." She is describing a kind of agency and autonomy women in her society rarely enjoy.
Her story and others like it confirm the belief held by Chandra Kochar, executive director of retail banking at ICICI, India's second largest banking institution. Chandra and ICICI view serving the poor as a critical financial practice with broad social implications. "When you touch the lives of these people through this initiative, you don't just touch their economic life," Chandra explains. "You touch their basic life as well."
Microfinance has touched the life of Ms. Saraswathi, the owner of a grocery in a small village in Andra Pradesh. "I had my shop before I joined the self-help group," she explains. "But it was very small. I used the loan to buy inventory. Of the 10,000 rupees I borrowed, I have repaid 6,000 so far."
For borrowers like Ms. Saraswathi, microfinance is not a lifeline but a catalyst that allows them to expand a small business and increase their income exponentially. Thanks to a microloan through ICICI, Ms. Saraswathi is now the owner of a thriving produce stand. But there are those who say that Ms. Saraswathi is not the ideal client for an organisation with fighting poverty as its aim.
There is a fierce debate in the industry as to whether microfinance is effective in reaching the poorest of the poor, and whether that should be its goal. At this point the argument becomes somewhat lost in semantics and the parallel discussion about the effectiveness of measuring both poverty and poverty alleviation.
"People have to understand that the poorest of the poor, for us, is a much wider group than the real poorest of the poor," explains Sebastian von Stauffenberg, partner at MicroRate, the industry's leading credit rating agency. "The poorest of the poor are the people who are just barely surviving. What makes microfinance such a great thing is that it taps into creativity and productivity of the individual. A person who is just looking to survive day to day is not looking to build a business."
I spoke to the heads of several microfinance institutions who agreed that a loan to the most remote and impoverished client is not the best idea for the institution or the individual. Their arguments were sound from a banking perspective. Sam Daley-Harris cautions:
If they adopt too much of banking, then we're back to banking and we leave the very poor out. International development consistently fails the very poor. Microfinance at its best is two revolutions: A revolution in banking and a revolution in reaching and empowering the very poor. I would expect international development, which has failed the very poor to tell us that you can't reach the very poor.
Enter Muhammad Yunus, for the second time. In 2002 Grameen Bank launched a Struggling Members Program, which provides tiny interest-free loans to beggars. Since the program's inception, $896,671 has been dispersed, of which $525,036 has been repaid. Currently, 76,000 people are Grameen "struggling members." Although they are not forced to give up begging, many have begun selling bread, candy, eggs and toys to earn supplemental income.
Struggling members are covered by the Grameen life and loan insurance policies at no extra cost. Grameen Bank enjoys unusual status as a profitable institution with a strong social mission, and this affords them the luxury of extending interest-free loans and premium-free insurance. But the programme's goal is developmental rather than charitable: The aim is for the struggling member to leave destitute poverty and join the 6.39 million regular members of Grameen Bank.
An Analogy for Expansion: Industry Growth
Some pundits compare this burgeoning industry to the Tower of Babel, with its disparate players, voices and concerns. Recent economic history, however, provides a better analogy. "It's like credit cards in the 1950s," says Michael Hokenson, managing director of Minlam Asset Management LLC, an investment firm focused on commercial investment opportunities in microfinance.
Beginning in the 1950s, there was huge demand in the United States for universally accepted lines of financing. This eventually led to the modern credit- card industry. The unmet demand for credit in emerging markets is today's market for microfinance. Early credit-card loan portfolios are remarkably similar to microfinance loan portfolios, in terms of their tenure, loan size and high repayment rates. What microfinance lacks is the standardization and customer communication that we see in the credit card industry today.
The dialogue between borrower and lender that put credit in the hands of middle-class people is the same customer dialogue that can lift millions out of poverty today. "Now we have to focus on forming deeper channels of communication in microfinance to extend lines of capital to broader populations," Hokenson says.
For that capital, microfinance has turned to the developed world for grants and investments. Citigroup and AIG, respectively the first and fourth largest companies in the world, according to Forbes Global 2000, have made substantial investment in the microfinance sector.
Multinational corporations actively engaging in microfinance face many communication barriers. Microfinance is practiced in a wide range of locales, languages and currencies. There is no watchdog organization, and standards are inconsistent from country to country. While it is encouraging that mainstream finance has begun to recognize poor people as viable clients, there is ample opportunity for the needs of impoverished entrepreneurs to be lost in the stratification of the industry.
Every level of communication in microfinance is of equal importance, considering that any inefficiency is passed on as higher interest rates and foreign exchange risk to the borrowers"the very people microfinance was designed to help and the ones least able to bear the cost.
Communicating the Value Proposition
Financial institutions need to communicate the value of these financial services to the people receiving them for the first time. Why, for example, should savings be deposited with a microfinance institution rather than stuffed under a mattress or converted into gold? Why, in a society where people struggle to survive from day to day, should a family pay for insurance against future disaster?
It is the responsibility of the institutions to foster financial literacy and articulate the benefits of the products they are selling. There must also be a two-way dialogue, in which clients first communicate their needs to a microfinance institution.
Often, this is as simple as leveraging technology to listen to voices that would otherwise go unheard. For example, a microfinance institution in Mexico realized that suggestion boxes and customer surveys were ineffective in gathering feedback from their borrowers, many of whom were illiterate or uncomfortable with filling out forms. Most of the clients, however, had cell phones, or access to them, and were accustomed to wireless communication.
The bank created a toll-free feedback line that clients could use to call in and suggest ways the bank might better meet their needs. Yet communication from the bank to the client is usually more difficult.
An AIG representative in India was asked by a self-help group to explain the micro insurance coverage that AIG offers through their local microfinance institution. Recognising that this would not be an isolated request, AIG in India commissioned a movie. They hired a Bollywood director to communicate the benefits and workings of their micro insurance policy using actors. "We like the model of using a local scenario to provide financial literacy training to the loan recipients," says Len Battifarano, a senior vice president whose team is responsible for developing products for the recipients of microfinance.
The film is narrated by a girl living with her family in a rural village in southern India. When a neighbour is killed in an accident, the village teacher pays a visit to the girl's family, urging them to hedge against future calamity with a micro insurance policy offered through their local microfinance institution.
If the scenario is a familiar one, the medium in which it is conveyed is equally recognisable. Bollywood produces the largest number of films in the world, and it is likely that people in the most rural areas of India have, at one time, been exposed to such films. The medium is best suited to this task not because of its familiarity, but because a film teaching financial literacy is more accessible to those who don't read. In the movie's closing scenes, the teacher explains that no reading or writing is required to take out a policy: You simply have to make your mark. To understand the benefits of insurance, however, all you have to do is watch and listen. The value is contained in a narrative of tragedy and poverty, a story that is all too familiar for many potential clients.
Point of Entry: Client Communication in Microfinance
AIG's innovations in client communication do not replace the degree of personal interaction and consultation on which microfinance was founded. When I asked various people who is responsible for communicating directly with clients, I was told again and again, "The loan officer," in a tone that implied a great deal of respect for that office. It is a rare thing in finance to see a senior executive display a deferential and almost reverential attitude towards a staff member, but given the importance of the loan officer as a communicator in the industry, it is hardly a surprise.
Maria Otero is a well-known, respected name in microfinance. She is president and CEO of ACCION International, a nonprofit microfinance network whose partner organisations provide loans to nearly 1.9 million working poor people in 23 countries. If Maria shows a particular admiration for loan officers, it is because she spent her first years at ACCION training them to understand the people they serve. She used to ride double with them on their motorcycles into the slums of Honduras to meet with borrowers. Loan officers fill the role Mohammed Yunus filled when microfinance first began"the person walking through the rural open market and communicating with clients. "The reason microfinance repayment rates are high is because you have figured out what the capacity to repay of each borrower is," Maria says. "And we gather that information mostly by interacting with people."
The difficulty of that job is compounded by the lack of development where microfinance is practiced. "When you're working with the informal economy," Maria says, "there is no balance sheet, no paperwork and there are no statistics to help you understand the characteristics of the people involved."
When a client has no financial safety net, there is no margin of error. There is a delicate balance between a loan that will lift the borrower out of poverty and a loan that will saddle them with more debt then they can manage. The success and sustainability of the industry depend on striking that balance, a balance that is contingent upon successful communication between the loan officer and their client.
A loan of the right size can create the momentum to propel its recipient out of the cycle of poverty. "I have seen business owners who started out with a $300 loan [end up with the ability to ] borrow $50,000 ten years later," Maria says. "And it's the same man who still has a third grade education, who still lives on a dirt street at the end of the block."
The Dollar Problem: Local Currency in Microfinance
For microfinance to sustain the level of growth that Maria Otero describes, funding from global capital markets is essential. But the denomination of that capital can be problematic. When a microfinance institution takes loans in dollars or euros from a developed economy and then lends ["on-lends"] that money to micro-borrowers in the local currency, they create foreign exchange risk that can bring an institution to its knees in the event of devaluation.
Bob Annibale, global director of microfinance at Citigroup, sees a direct connection between loans-in-hard currency and the probability of default. "If you have foreign exchange risk, in my mind, you have credit risk," he explains. "You leave an institution with a risk it may not be able to handle."
Currency is hardly a new issue for Annibale: Before he took charge of microfinance at Citigroup he was senior treasurer risk officer. His experiences in that position shaped how he runs Citigroup's global microfinance operation. "Our programs have been local currency-based programs that we do around the world," he says.
Emerging markets have historically found it difficult to borrow in their own currency. Having large amounts of "dollarised" debt can be catastrophic for an emerging market's economy in the wake of exchange and interest rate adjustments.
According to Minlam's Michael Hokenson, who has more than 10 years experience in emerging market entrepreneurial ventures, "we need to provide deep lines of local currency to microfinance institutions. By doing so you strengthen the value proposition to the client and the industry as a whole." Money in microfinance, it seems, talks loudest when it speaks the local language.
Development Dialogue: Communication Across the Industry
Most of today's microfinance investors are drawn to the industry because of the way it combines social impact with a potential return to form an attractive double bottom line.
But for money to travel from an individual or foundation to the end client"the woman living in poverty with no access to credit"the money must first find its way into the hands of a worthy microfinance institution.
In an industry as far-flung and fragmented as microfinance, independent assessment of these institutions is difficult to come by, but essential.
MicroRate, founded by Damien von Stauffenberg in 1996, is the oldest rating agency in the industry. After spending 25 years at the World Bank and the International Finance Corporation, von Stauffenberg realised that the microfinance institutions receiving the most funding were not always the most worthy from a financial or social standpoint. So he founded MicroRate to provide independent analysis to investors
MicroRate rates the performance of microfinance institutions. Because most investors are concerned with a social as well as a financial return, and because the nature of a microfinance institution defies traditional credit rating procedures, MicroRate was forced to change industry practices.
"An officer of a traditional credit rating organisation will spend most of his/her time on a desk analysis and will spend at most a day with the client," says Sebastian von Stauffenberg, MicroRate's general manager for Latin America. "We spend three, four, five days with the microfinance institutions. We go out in the field with their loan officers, we see their loan committees. There's no other way to assess how good a microfinance institution really is, because it's not a matter of numbers. It's a matter of methodology."
MicroRate, along with the Consultative Group to Assist the Poor, coined the term microfinance investment vehicle to describe funds that channel money from investors to a microfinance institution. The company has identified 59 investment vehicles and aims to be the first independent source of information on the links between global capital markets and microfinance institutions. If it succeeds in bridging the divide between investors, investment vehicles and worthy microfinance institutions, it will be a significant contribution to the field.
The Aim: Obsolescence
Microfinance will have succeeded when it becomes obsolete, when access to basic financial services is no longer a novelty or a development initiative.
"No one addresses what the endgame of microfinance should be," says Reuben Abraham. "I think what the endgame of microfinance should be is to make itself irrelevant."