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 MicrofinanceMicrofinance 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.
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.
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 IssuesThere 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 StabilityThe
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 SupervisionThe 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:
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:
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:
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.
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
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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