Presentation Mr. Yusuf IVP-BRI

Developing Sustainable Microfinance:

Policy and Action

Mr. Mohammad Nazirwan and Mr. Yusuf Nawawi

Nazirwan is Senior Microfinance Specialist of Bank Rakyat Indonesia

Nawawi is Director of the International Visitor Program of Bank Rakyat Indonesia

1. Background

Since the last two decades, we have witnessed a significant development of microfinance initiatives around the world. This rapid proliferation is a result of success story of microfinance in providing financial services, primarily credit and savings to a large number of poor clients who do not have access to formal financial institutions in many developing countries. As a development tool, microfinance is considered as one of the most important financial resources for poor people to conduct household economic and income generating activities, which can reduce their vulnerability, and allow them to accumulate capital and valuable assets. In another perspective, microfinance is also means of helping micro entrepreneurs to expand their businesses to the point of viable business and eligible for credit from commercial banks.

Recently, microfinance has been more advance in meeting the needs of millions of poor for financial services. As a human being, the poor needs these services for the same reasons as everyone else, to save some cash in a secure and convenient manner, to finance businesses, to obtain loan for buying piece of land and property, to pay electricity bill, to send money to their children who study in the cities and to insure them against risk.

Obviously, developing a sustainable microfinance system has been a great concern among members of the Non Align Movement (NAM). With its 114 member countries, mostly developing ones, the organization represents two-third of the world population, as well as home for the majority of poor people

This paper explores the future issues and strategies of developing a sustainable microfinance, which will be certainly more complex and dynamic. Indeed, to predict the future is not easy. However, in the perspective of practitioners, there are some interesting issues, which may be predominant in shaping the landscape of microfinance industry. Before discussing those issues, it would be necessary to review the past and the current stage of microfinance in order to gain better understanding of the industry.

2. The Development of Microfinance

Microfinance emerges as a lesson learned from the mistaken policies in the past. The initial development of microfinance (popular term was rural finance) was highlighted by supply-leading finance paradigm which emphasized on subsidized credit program for supporting peasant farmers in rural areas, and massive donor funding for alleviating chronic poverty. In the next stage, the approach has gradually shifted into market-driven which more focus on providing financial services including voluntary saving products to economically active poor and microentrepreneurs.

2.1. Supply-leading and Poverty Lending Approach

Rural development issues have been intensively discussed since early 1950s in response to conditions after World War II. Economic development experts recognised that a critical element of development strategy was to stimulate food cultivation, rural development, rural incomes, and rural employment. Therefore, the economic development program should encourage the adoption of modern technology in agricultural activities and the use of production inputs such as seeds, fertilizers and pesticides. Moreover, to enhance the economic growth in the rural areas, the farmers needed credit to attain the production inputs. Supply-leading approach assumes farmers either lacks of capital and/or did not have enough access to financial sources, if any they were charged high interest rate by informal sources. To obtain production inputs, therefore, there should be a system that was available to supply loans and inputs required to cultivate the new high-yielding varieties of rice and wheat at subsidised interest rate. In doing so, numerous developing countries developed rural financial institutions which primarily oriented to the provision of credit to farmers and was tied to specific agricultural packets or technologies. However, the supply-leading strategy had temporarily succeeded in disbursing credit to the target groups but it failed to achieve the objectives to serve the rural poor and to be sustainable credit institutions.

With a similar perspective to combat chronic poverty in many under developing countries, international donors and development institutions have developed anti-poverty initiatives, which pioneered by Professor Muhammad Yunus through Grameen Bank in Bangladesh. The poverty lending approach focuses on reducing poverty, through providing microcredit and other complementary services to the poorest of the poor particularly women at very low cost (subsidized). The Grameen Bank model has been replicated and used in many developing countries but their sustainability has been questioned because they much rely on funding and grants from donors, which relatively limited. In addition, the interest rates on microlending are too low to achieve cost recovery and, therefore, they require frequent recapitalization for long-term operation.

2.2. Demand Driven and Financial System Approach

A number of empirical studies reveal that repressive financial system and subsidized loan approach for rural development had actually been counterproductive which lead to the new approach that derived from market-based concept. The financial system approach focuses on demand of commercial financial services of the poor borrowers and savers. The transformation of BRI-Unit from channeling agent of subsidized credit for agricultural lending to microfinance entity, and the transformation of BancoSol from NGO to be a commercial microfinance institution are the foremost examples of the financial system model. These institutions provide easy access to credit at reasonable interest rate to the economically active poor and microentrepreneurs, and offer convenient and safe saving services for people who want to store cash and to gain positive interest rate on their investment. Generally, the loan portfolios are financed by savings and retained earnings and in some cases only limited funds come from donors. The main objective of this model is to reach institutional financial self-sufficiency and to reach wide outreach to low-income clients profitably. However, there is a growing criticism on this approach particularly on its roles in serving the bottom layer of the poor.

3. Microfinance as a part of Financial Mainstream

Inevitably, the microfinance industry is becoming mature and more dynamic, associated with market changes. Recently, microfinance sector has changed radically and will continue to develop over the next several years as there are millions of poor who demanding the financial services for livelihoods. To challenge the needs, microfinance industry should move from credit oriented to more variety products and services such as deposit facilities for accumulating capital and investment, payments services, money transfer and foreign exchange transactions. In addition, there is a concern of other financial services such as micro leasing as an alternative for business financing and micro insurance for coping with risk. Furthermore, Marguerite Robinson in her book The Microfinance Revolution, Sustainable Finance for the Poor also states “The microfinance revolution is a commercial revolution, based on new financial technology and greatly accelerated by the information revolution that developed concurrently”. Simply put, a combination of advance financial technology and the rapid development of information and communication technology (ICT) have driven microfinance industry to be part of the modern financial mainstream.

3.1. Balancing Between Credits and Savings

The root of microfinance was micro credit, which has dominated most of discussions, initiatives and activities focused on how to deliver the credit and how to assure the money safe in the hands of poor people. Moreover, as microfinance sector has become mature at the one hand, and because of growing needs of deposit services by the clients at the other hand, many experts, practitioners and donors starting to put their interest on deposits (voluntary savings) mobilization.

From the perspective of a microfinance institution (MFI), savings mean source of funds that can be lent to the borrowers. In this context, higher saving rate will increase the flexibility of MFI to expand its loan portfolio, which can lead to higher profitability. In reverse, lower savings capacity will diminish the ability of MFI to increase the business as well as profitability.
Savings is cheaper funds if deposit services are priced properly. The experience of BRI-Unit and studies on Credit Unions in Latin America show that cost of fund of saving tends to be lower than interest rate in money market. In other words, higher savings will allow the MFI to set up competitive interest rate on lending and reasonable profit margins.
Introducing savings facilities may improve the outreach and expanding new services and products. A stable savings can liberate MFI from donor and government aids in order to achieve self-reliance financing for the long-term operation, as well as lower liquidity risk.
Saving can maintain balanced governance. The presence of net savers will create a pressure on management of MFI to conduct a prudent operation that can lead to public confidence and stability of the institution.

There are critical issues that should be addressed in establishing savings mobilization. First, sound macro-economy and financial sector environment including an appropriate legal, and regulatory and supervision framework. Second, strong governance, ownership, and institutional structures which can demonstrate good management on the funds. Third, advance financial management capabilities that focus on liquidity and risk management practice. Fourth, market-oriented products and mechanisms that fit to the preferences of poor clients. Finally, human resource empowerment through capacity building program as well as incentive system development on staff performance.

The Role of Information and Communication Technology (ICT)

There is no doubt, that ICT has rapidly transformed the way of human life and provided huge opportunities and advantages including for microfinance industry. Recent ICT developments have allowed MFI to increase outreach and operational coverage, lower overhead cost, and provide more affordable and flexible financial products and services to more poor clients.

Like in any other financial sector, information is part of microfinance industry. Microfinance institutions, whether manually or computerized, deal with large number of important business data and information, such as client information, financial transactions, portfolio statistics and so forth that must be maintained, manipulated and managed for making sound management decisions. Management information system (MIS) is a critical factor for the success of MFI. Through a good MIS, MFI will be able to access and analyze information more efficiently and to streamline and shorten the flow of information and to make in time decision-making process.

In addition, the forces of ICT development allow microfinance institution to create better products and services with more options. One of good example is smart card with embedded microchip allows MFI to shorten transaction times and to track consumer information as well as to overcome the limitation of online network. The implementation of automatic teller machines (ATM) for financial transactions also permits MFI to reduce transaction costs and provide better services to customers. Through ATM, clients are able to withdraw funds, transfer funds between accounts, and making payments in very convenient way and locations at any time. The application of Personal Digital Assistant (PDA) allows loan officers to access the MIS from the field and also cut loan officer client transaction times. The development of Internet, mobile phones and wireless communication technology have also transformed MFI in terms of how to provide services and communicate with clients, among themselves and to the world.

Indeed, ICT is a powerful tool but also source of problems if it does not properly designed and implemented. In addition, lack of internal controls, poor staff morale and inadequate infrastructure will generate potential problems for microfinance institutions.

4. Strategic Issues

There is an international movement that put microfinance as one of the key issues in achieving the “The Millennium Development Goals” by 2015. In response, international development banks and bilateral foreign assistance agencies, the governments of developing countries, academics and practitioners have focused on working to strengthen the microfinance industry in order to provide sustainable access for poor people and micro entrepreneurs to financial services. To ensure these supports, strategy formulation should focus on establishing policy environment that is conducive to microfinance, developing regulatory and supervision framework, building institutional capacity.

4.1. Policy on Macro Economy and Financial System Stability

The role of state in managing macro economy and financial stability are essential for developing sustainable microfinance industry. The policy of the government should also include the provision of infrastructures, education and skill development, and job creation that are essential for accelerating informal sector which is closely associated with microfinance. The governments also put more attention on how to control inflation rate, and establish appropriate regulations that focus on interest rate reforms particularly on credit and savings. In addition, it is also important to educate bureaucracy and the public about microfinance and its importance for the economy and for development.

4.2. Regulation and Supervision

The rationale of regulating and supervising microfinance sector is to maximize the functions of the industry in providing financial services for poor clients. Therefore, it is necessary to ensure that the regulatory and supervisory framework is flexible and provide incentive both for clients and providers. In addition, the system of regulation and supervision should be designed to balance objectives and interests of different parties. Among other things:

Protecting the financial system from unsound practices that can have domino effect on the whole financial system particularly MFIs which heavily rely on funds from commercial banks or other financial institutions.
Protecting and providing legal support to small depositors
Promoting the industry regulation and supervision that may attract more deposits from the public, and make possible for MFIs to obtain financing at lower cost.
Protecting public funds in case the liabilities of MFIs are not covered by blanket guarantee from government or by public deposit insurance.

4.3. Institutional Capacity Building

Strengthening institutional capacity is one of the key issues for sustainability of microfinance institutions. Strong institutions together with good governance will be able to provide good quality financial services to the poor, increase MFIs’ outreach significantly, and achieve financial self-sufficiency. There are some critical issues should be taken into account:

Improve management capacity i.e. become more autonomous and be able to adapt sound governance practices
Improve the operation and procedures that focus on increasing efficiency, lowering transaction costs, improving client satisfaction, and ensuring that earned income covers operating and financial expenses.
Enhance management information systems and accounting policy i.e. more timely informative and transparent.
Strengthen internal supervisory system and audit capacity, integrated with daily operation and routines.
Develop risk management framework (comprehensive strategy for arrears, and fraud prevention)
Develop human resources through career development, training programs, and corporate culture
Provide adequate physical infrastructure, convenient offices and close to the customers.
Develop products that is suitable to the market

5. Concluding Remark

In the past, we witnessed microfinance has been successful as an anti-poverty and development tools. Now we are witnessing microfinance moving forward as an industry, which benefit million poor people, poor women, microentrepreneurs, peasant farmers, and the society. In the future, we will witness microfinance, it is hoped, as a lucrative business opportunity through providing financial services for the poor.

Aside from technical and implementation issues which might vary from country to country, the framework for building sustainable microfinance should be guided by a shared goal. This goal should be a comprehensive one, which containts a balance between commercial and social objectives

In our perspective, long-term objective of microfinance development should cover the following milestones:

Sustainability

To be sustainable, a microfinance system has to be able to generate enough profit to cover its operating and overhead costs, and to finance a continous development. In addition, the microfinance system also need to mobilize savings to fuel its lending activities and to avoid dependency on donor funds.

Outreach

When a microfinance system has reached the point of sustainability, then it has the capacity to extend outreach. Although some argue that microfinance as a development tool has to put outreach as the first priority, we believe that only a sustainable microfinance system can do that

Impact

In most studies, the impacts of microfinance (on poverty alleviation and rural development) is often measured by level of outreach, such as the number of poor people served, the number of women clients, etc. However, we see the impact in a broader sense, including social impacts and creation of monetary system in rural economy.

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