PRESENTASI KELOMPOK 1

THE CHANGING LANDSCAPE OF MICROFINANCE

INTRODUCTION

The ability of households to save, access capital, and manage risk exposures of various kinds, such as life, property, and health through insurance is a prerequisite for their economic and social development. Access to basic financial services (such as credit, savings, and insurance) is most likely to develop the entrepreneurial skills and opportunities among those poor who are currently outside the perimeter of such financial markets and services. Furthermore, over time, such access will promote better risk management capabilities and promote the economic aspirations of the poor. It should be made clear that while the provision of low-cost access to financial services is an important ingredient in alleviating poverty, there are a number of other basic services that are unavailable to the poor. These constraints include (1) absence of primary education, (2) absence ofprimary health care, and (3) relatively primitive technologies used by the households. These constraints need to be tackled in parallel as the momentum to deliver financial services gathers speed. There are significant complementarities between access to financial services and the ability of the poor to access education, health care, and better technologies.

FORMAL AND INFORMAL MARKETS

Organized stock exchanges, bond markets, dealer markets, commercial banks, insurance companies and other institutions, constitute a vital part of financial architecture of most economies, whereby households and institutions are able to allocate their savings and have access to capital. These markets and institutions are known as formal markets for financial services. Formal credit markets consist of institutions such as commercial banks, credit unions, rural banks, and other financial institutions, which are subject to public and private oversight and regulation. They are governed by bankruptcy codes, investor protection laws, and disclosure requirements.

In the past and to a significant extent even now, poor households have tended to rely extensively on informal markets for their capital needs and other financial services such as insurance or savings. Indeed, these other financial services have only recently become available to poor households through microfinance. Informal credit markets typically operate outside the perimeter of regulators and are often not subject to monitoring and supervision by governments or agencies of governments. The rights and responsibilities of lenders and borrowers in such markets do not come under a formal bankruptcy code. Players living in close proximity to such markets often have detailed knowledge of each other. Examples of such informal markets and participants might include the following: (1) family members, (2) friends, (3) trade credit from local shops, (4) professional moneylenders in the region, (5) pawnbrokers, (6) local landowners, and so on.

EVOLUTION OF MICROFINANCE

Informal credit markets described in the previous section have preceded microfinance. Institutions such as credit unions and specialized lending programs targeted to agricultural sectors have also been in existence since the early 1900s.5 The seeds for microfinance in its current form were planted during the period 1950–80, when small loans were extended to poor borrowers who could not post meaningful collateral. Major organizations, which pioneered this initiative, were ACCION International in Latin America, SEWA Bank in India and the Grameen Bank founded by Muhammad Yunus in Bangladesh. These initiatives demonstrated for the first time that poor borrowers, especially women, were not only willing to take on smallscale projects funded by loans, but were also capable of chalking up excellent payment records.

Technological innovations have also paced the evolution of microfinance: widespread availability of mobile phones, access to community-level kiosks of computer terminals with access to the Internet, biometric technology to obtain loan approval and credit history, and correspondent banking have dramatically changed the landscape of microfinance. As we will demonstrate later in this chapter, traditional institutions such as NGOs still remain an important force, especially for the poorest of micro-borrowers. In the upper tier of the microfinance, capital markets are actively helping microfinance institutions to tap debt and equity capital. New market institutions have developed, which are likely to improve the transparency and potentially reduce the cost of accessing financial services: for example, a recent study has reported that the microfinance institutions (MFIs) in countries with credit bureaus tend to have a 5 percent lower operating expense ratio than the ones in countries without credit bureaus.8 Credit rating agencies have developed in countries that rate institutions in microfinance. Two rating agencies, MicroRate and M-CRIL are well established in the field.

QUESTIONS ADDRESSED IN THIS BOOK AND A WORD ABOUT DATA

These questions form the intellectual basis for this chapter. To motivate

these issues, examine some of the studies that have used MIX data, in order to shed some light on the issues studied here. Before delving into these questions, it is useful to note the following properties of MIX data. MIX data is based on voluntary reporting by 704 institutions to a detailed survey conducted by MIX. As of 2006, the survey covered more than 52 million borrowers with $23 billion in loans. The survey also covered 56 million depositors with over $32 million in deposits. Clearly, these

figures are a downward-biased estimate of the true size of the microfinance market. It is also conceivable that the participating institutions are qualitatively different from the non-participating institutions, which are likely to be smaller and more donor-financed.

Cost of Access to Credit

Lacking micro-level data, it is difficult to estimate the costs of obtaining financial services to the borrower in the microfinance area with great precision. In a recent paper, CGAP (Consultative Group to Assist the Poor) reports that the interest yield for Compartamos (a lender in this market) stood at 86.3 percent!9 CGAP estimates that the cost to the micro-loan borrower is about 100 percent when taxes are taken into consideration. This data corresponded to the 2005 period when the median interest rates charged by village banking MFIs stood at 47.2 percent, and the interest rates charged by low-end MFIs stood at 35.4 percent.

Gonzalez (2007) provides an analysis of the MIX database. We can estimate the interest costs faced by the borrower. Our first estimate is the yield on gross loan portfolio. This measure takes the ratio of adjusted financial revenue from the loan portfolio to the adjusted average gross loan portfolio. Financial revenue includes the revenue from the loan portfolio and other assets plus revenue from other financial services. Such services may include insurance, passbooks, smart cards, and so on. For our purposes these expenses are relevant to the measurement of the costs of financial services. Gross loan portfolio excludes write-offs.

Table 1.1 Costs of obtaining financial services—variations across

institutions (in %)

Institution	2003	2004	2005
Banks	33.7	36.9	28.3
Credit Unions	22	20.2	20.4
NBFI	32.6	32.1	29.3
NGOs	42.5	40.2	38.6
Rural Banks	27.3	26.8	23.2

Table 1.2 Costs of obtaining financial services—variations across target groups (in %)

Target Group	2003	2004	2005
Low End	37.8	37.8	35.4
Broad	34.5	33.7	31.1
High End	24.1	24.1	22.7
Small Bussiness	24.8	22.7	22.6

Finally, there are reasons to think that the average costs of participating in this market is expected to go down significantly due to the advent of technology such as biometric screening, smart cards, and the delivery of loans by mobile phones. This said, it is clear that the borrowing costs must come down significantly in order for microfinance to be a credible and sustaining avenue for poverty alleviation.

Contracting and cost of access

As noted earlier, lenders utilize different contracting methods to extend loans. Some borrowers get “individual loans” and others are part of a “solidarity group” where the group is jointly liable for the loans taken by the members.

Capital structure and default risk

The cost of extending financial services such as credit and insurance reflects the costs of accessing capital for different lending institutions and the risks High debt/equity ratios of banks, credit unions, and rural banks may reflect their inability to get sufficient equity capital and the relative ease of access to debt capital. In the next subsection, we provide some evidence concerning the ability of microfinance institutions to tap into debt and equity capital.

Role of Capital Markets in Financing and Investment in Microfinance

Microfinance began largely as a philanthropic effort or a quasi-philanthropic effortGovernment-mandated programs such as rural banks, and branch expansion by nationalized banks into rural areas, are examples of such effort. Non-governmental organizations (NGOs), who supply of capital is largely donor-based, dominated the scene. In fact, an analysis of the MIX database shows that there are over 400 NGOs and over 100 rural banks that extend financial services as of 2006. Indeed, this evidence demonstrates the very key roles that these groups continue to play in microfinance. But we have seen a very active interplay between capital markets and microfinance: increasingly, capital markets are being used to source capital for providing microfinance services. Indeed, we tend to see a tiered market: some of the top-tier microfinance institutions are able to access capital markets for fairly large chunks of capital

Technology and Microfinance—Opportunities and Challenges

In an earlier sub-section, we noted that the borrowing rates in microfinance

markets can be rather high. In addition, we noted that the delivery of financial services such as tiny loans and insurance payments, and accepting tiny savings deposits require that the service providers overcome (1) significant transactions costs, (2) adverse selection problems, and (3) moral hazard issues. In fact, a skeptic could reasonably ask how microfinance could be the mechanism for alleviation of poverty, if the interest rates are so high, and if scalability is simply unattainable due to the factors outlined above. Technological developments over the last decade hold much hope in overcoming these obstacles.

Electronic matching of borrowers and lenders: search and delivery costs

One of the factors that contributes to the relatively high interest rates on loans is the cost associated with search and delivery of loans, and the subsequent efforts that are needed to manage the default risk of the loan portfolio. The Internet has opened up new vistas for matching borrowers and lenders electronically, and the developments that we have seen in the last decade have the potential to lower the costs of very small loans. On these websites potential lenders are able to view and evaluate loan requests, ranging from about $1000 upwards, and bid on them. Most of the loans are of short duration, not exceeding three years. Legally binding contracts are entered into. Information about credit scores is used in contracting. Monthly payment schedules are enforced.

Correspondent banking and biometric authorization of credit

A development that has accelerated the access of financial services to the poor is the concept of “correspondent” banking or branchless banking. This has been especially successful in Brazil, and the concept is bound to have a major effect in other regions.23 Under this concept, local post offices and shops are equipped with barcode-reading point-of-sale (POS) terminals. These local entities then act as agents for banks. It is estimated that currently there are nearly 100 000 such correspondent entities in Brazil alone. CGAP estimates that nearly 13 million customers have been brought into the fold of the banking system through these correspondent networks. It is well recognized that the literacy levels of microfinance borrowers are rather low. This presents unique challenges in reducing the costs of lending to them. One technological development that has entered the field of microfinance is the application of fingerprints for the purpose of identifying and validating financial transactions, through ATM networks.Biometrics and smart cards are already in use in microfinance in India and Indonesia. Biometric teller machines (BTMs) reduce the administrative costs of extending small loans in communities where the literacy levels are low. The smart card contains the credit history of the borrower. Banks

such as ICICI in India and Danamon in Indonesia are employing such

technologies.

Village Internet centers and eChoupals

One of the developments that has occurred in the delivery of services to poor citizens in remote corners of the world is the proliferation of community Internet centers, which deliver both the infrastructure and information that may be utilized by small agricultural producers to get the best possible price and thus eliminate intermediaries.24 Some see this development as using the technology to empower as well as significantly increase the range of services to the poorer sections of society. One such innovation is the concept of eChoupals, pioneered by India Tobacco Company (ITC), which deliver price information and an infrastructure for buying the agricultural production from small farmers. eChoupals are village Internet kiosks run by local entrepreneurs who provide pricing information for different delivery dates to local farmers and enable the farmers to sell their produce directly to ITC, bypassing the intermediaries. Farmers benefit from a known price schedule, and ITC benefits from the elimination of commissions and transactions costs that intermediaries would have charged.A question that naturally arises is whether there must be some oversight on the interest rates charged by microfinance lending organizations. Since the borrowers are often not well educated, another question is whether they fully understand the effective interest rates that are being charged by the lending institutions. Such effective interest rates will have to reflect a number of factors such as:

(1) Frequency of compounding and payments,

(2) Transactions costs charged,

(3) Costs of any mandated insurance policies,

(4) Efforts associated with compliance—peer-monitoring efforts,

time spent with loan officers, and so on. Full disclosure of these factors may not always take place. The risk of default is managed by the lenders through various methods:

(1) forming groups that are less risky,

(2) contracting with built-in incentives for peer monitoring,

(3) frequent (often weekly) payments where feasible,

(4) extensive lender monitoring, and so on.

Savings and intermediation

Many microfinance institutions also accept savings deposits and provide other services such as insurance. The direct and indirect costs associated with the provision of these services should be transparent to the consumers of these services.

Table 1.5 Gender empowerment—percentage of women borrowers across

lending institutions and regions

Region Banks Cooperatives and Non-bank NGOs

Credit Unions Financial

Institutions

Africa 52 39 62 81

East Asia 61 N/A 86 98

Latin America 52 52 52 71

South Asia 97 99 65 100

Table 1.5 documents the distribution of the fraction of women borrowers in the sample, split across geographical regions and the types of lending institutions.33 While this is admittedly a very aggregated picture, which may potentially mask country-specific sociocultural dimensions, it still provides an interesting breakdown. The data clearly show that the gender empowerment is extremely strong in South Asia, and to a lesser extent in East Asia. It is much less so in Africa and Latin America. Indeed, for micro-loans extended by banks, cooperatives, and credit unions, and non-bank financial institutions, we find that the borrowers are very nearly evenly split across the gender in Latin America, and roughly so in Africa.

Microfinance borrowers are targeted for credit either on an individual (stand-alone) basis or as a part of a solidarity group (group-lending) basis. The benefits of a solidarity group and the associated peer monitoring effects have been addressed in the literature. In addition, there is the concept of village banking, which is another self-help group (SHG) consisting of very poor borrowers, with low per capita income.

Table 1.6 Percentage of women borrowers across different institutions

2003–05

Year Banks Credit Unions NBFI NGO

2003 52.8 73.0 53.8 79.0

2004 50.0 56.5 60.8 82.1

2005 52.5 60.0 56.1 79.7

Source: Gonzalez (2007).

Table 1.7 Percentage of women borrowers across different contracting

arrangements 2003–05

Year Individual Individual/Solidarity Solidarity Village Banking

2003 47.9 67.9 82.0 90.3

2004 53.9 66.2 92.0 94.5

2005 51.8 62.0 100.0 90.2

Source: Gonzalez (2007).

MEDIAN LOAN SIZE

Table 1.8 shows that the median loan size of the NGO borrowers is, by an order of magnitude, smaller in each region when compared with other borrowers.

Table 1.8 Median loan size in US$ across lending institutions and regions

Region Banks Cooperatives and Non-bank NGOs

Credit Unions Financial

Institutions

Africa 529 373 215 129

East Asia 562 N/A 235 90

Latin America 1445 1510 1039 437

South Asia 127 124 126 107

Source: MIX data (2006) and author’s analysis.

MEDIAN TOTAL ASSETS

In South Asia, the median assets of banks are nearly five times the median assets of NGOs. In Latin America the corresponding multiple is 46, and in East Asia, the corresponding multiple is 550! These numbers point to the increasingly dominant role played by banks in extending financial services to poor borrowers.

The issue of gender empowerment in microfinance requires a careful study at two levels: first, at a suitable level of aggregation (perhaps at a country or a regional level) in order to better understand how it comes about and what the evidence is from a development perspective. At a second level, we need to address this issue at a very micro level: do we see group-based lending and greater gender empowerment going hand in hand? Is there a significant positive association between first-time borrowers (who are likely to be among the poorest) and gender empowerment?

First, we want to document clearly the developmental and social benefits arising from targeting women in microfinance to guide future efforts. Second, we need to better understand why this empowerment does not appear to be present with some lending institutions in some countries, at least in the context of the evidence presented from the MIX database.