The Psychology of the Microfinance Market

By Peter van Dijk,

The only agreement in Microfinance seems to be the ultimate goal that it should reduce poverty. A decade ago, the Micro-debt part of the sector, which now is a large employer in Europe and North America, predicted that if they would receive some billions of $US more in socially motivated funds they would ensure that millions households receive loans and that each year 5% of those borrowers would be poor no more. They received promises from the G8 countries to that effect, from the UN and the World Bank Group in Monterrey (2002) and Gleneagles (2005). Well, the goal of significant poverty reduction seems to be far off now and the Microcredit arm of the Millennium Development Goals is busy getting its defence up; that they are not to blame for having failed the poor. That Microfinance has not evaporated as a trend in socio-economic development may be due to the fact that it concerns the always happy activity of “giving away money” and that all people involved can get away by arguing that they are extremely successful in helping “their” poor clients and they have widely smiling clients on pictures to prove it. And the poor will always need money from whatever source, they will not try to invoke their individual rights to get compensation for false promises.

Some things have improved. As I explained in an earlier article in MFF, many practitioners who argue that Microfinance is about “distributing financial services to poor people”, especially “ loans to economically active people” have come to understand that collecting, stabilising (in the form of specific longer term savings products) managing and on-lending of customers’ deposits helps their clients as well as the Microfinance institution. It increases the assets of poor people so that they become less poor, it helps the poor better plan their money, it helps to better know customers thus improving risk management and it may reduce funding costs thus contribute to bringing down lending interest rates. Some of these experts have learnt from their twenty or so years of grassroots experience and transformed their organisations, such as GrameenBank. However, at international conferences, such as Prof. Yunus at the Nobel Prize acceptance speech, they still speak for an hour without even mentioning once the terms deposits, savings or financial intermediation. Why is that?

Over the last five years many different new issues have entered the scene and are being tried with so many different approaches; technological support (computerisation, mobile telecommunication technology),  “value chain financing”, “social performance measurement” (SPM), individual uncollateralised cash-flow based lending, MFI transformation into retail banking, etcetera. And of course the promoters of micro-enterprise development and credit still dominate the public media with their slogan that Microfinance is defined by loans for working capital for the “economically active poor” (a confusion on its own; is not every poor person getting money from whatever source possible in order to stay alive and thus “economically active”?). These many different activities produced an important level of confusion. They are not presented in a manner that can build a viable business model in a specific market. How does a socio-political lending program focusing on women groups that have subsistence business activities organises itself to manage itself to decide what it wants to do in the future? If it wants to principally remain a tool for women groups to meet and discuss different issues other than finance, which of the above tools would it need to improve these activities? If it wants to become a rural finance institution how shall it dispose of its non-financial services and how will it manage members that do not want or understand that change? What future plans should Savings Clubs make if they want to better structure their activities that now end each year by dividing the savings? How can an MFI transform into a retail bank that can continue to integrate so far unbanked people, including diversifying clients and products, in a process where it determines independently which tools it can use in what sequence and in a manner that ensures its financial sustainability and sustained growth?

Continuing that confusion, many social Micro-lenders mix different kinds of funding sources for realising their confused ideas: deposits from their customers, deposits from neighbouring citizens who desire only safekeeping of their money, borrowings from local commercial banks, commercial investments from local businessmen, grants from local governments, subsidies from foreign donors, “social” investments below local and international capital market rates, “subordinated” loans that have no real debt obligations and are below market conditions, and in general help from everybody who wants to give something, buildings, uniforms, money, cupboards, training, advice etcetera. Such confusion and the temptation to welcome any outside offer of support and advice are understandable. In some countries microcredit institutions were told that they needed to mobilise and on-lend public deposits and central bank was instructed that they should provide such organisations with licenses. As a result, trends can be observed in some countries of slowing deposits, continuing short term nature of such deposits (still desperately and incorrectly called “savings”), continuing rapid growth of lending that results in over-indebtedness, criticism on high interest rates, creative accounting and slowly worsening repayment performance.

What can we, Microfinance practitioners, authorities and experts of all kinds do to help poor people and their (micro-) financial institutions to better manage money? How can we help citizens and businesses to work with (micro-) financial institutions to integrate into sustained economic growth and job creation processes through financial intermediation?

I suggest that we start by understanding the processes at work in local markets. If a market is about interchangeable goods or services with similar characteristics, usage purpose and pricing then we can conclude that in some geographic areas microfinance is a different market than banking and should thus not be policed and regulated in the same way. In other areas it even means that services called Microfinance are different between them and should be distinguished and separated into different markets, with different authorities, players, rules, as well as with different appropriate support mechanisms. In most countries Microfinance stretches out over different markets and one can consequently not talk about “promoting competition to support growth of MFIs”. Experts, authorities and practitioners need to first understand and agree on the existence and workings of the different markets before making a strategy for integration of Microfinance in one or the other.

It seems clear to me that social microcredit should be separated from Microfinance as a tool for building inclusive market-oriented financial sectors. It might hurt the social experts who have gotten rather fond of using banking and other financial sector terms; blaming bankers for greed whilst undertaking “banking of the poor” and sometimes becoming rather good at it, with profits, share-value increases, IPOs and all, or by sometimes cleverly hiding profits by talking instead of autonomy and cost-covering. In some instances such social experts became very successful in undermining any local efforts of forging an alliance for local financial intermediation where local excess funds are used for local re-investments in economy and society. Again I personally think also that citizens, also those that sit in banks and in governments, are in the long term more committed to local sustained development than foreigners. Foreigners are more easily tired of local challenges, find less performance incentives and their project term often ends in three years. I also think that equitable, locally determined salary earning is key to promoting professionalism and to maintaining a stable national currency and stable financial markets, simply saying that local monetary policies make sense. It also means to say that I think that, with all due respect to their commitment and role in humanitarian activities, only activities remunerated according to a commercial pricing mechanism will feed economies and thus the citizens who live there.

Foreign support in Microfinance of any kind can only contribute marginally when they fully understand, respect and integrate into the local socio-economic growth process. And Microfinance experts also need to understand how individuals respond to specific financial stimuli. People are not machines, markets are not perfect and markets of social, economic and financial products and services in many countries are twisted and mixed up. Especially poor people are often discouraged and impatient, they often don’t act rationally but opportunistically. By clearing the area, by clearly defining specific markets, their players and (potential) customers, experts can help increase understanding. MF experts can assist in making the data that MFI produce and transfer to the public authorities detailed, reliable and verifiable without making that process cost a lot of time and resources. The authorities can thus do their work and form an accurate image of the operations and health of the institutions and of the clients they service. They can determine in which markets MFIs operate, in the banking sector or in social affairs and regulate these separate markets better on the basis of clear and consistent strategies and policies.

Finally, it is has been “high time” indeed that foreign donors are held accountable for failures, violations of local policies and laws, and for damages caused by their work. Damages that are caused by distorting markets and violating consumer rights. How to solve a conflict between a social lender that provides loans at subsidised interest rates where an MFI tries to become self-sustainable; who should pay for the direct and indirect costs for implementing a solution? How should a borrower get its rights reinforced when a micro-lender applies one-off fees and charges on top of interest rates in violation of lending and consumer laws (“transparency in lending”)? Will the donor of the microlender pay for all the legal and miscellaneous costs where a local authority has clearly established that the borrower has justified cause? Will the mobile telephone company pay when its independent pre-paid card seller or POS-payment machine agents lose money that was collected from depositors in “branchless banking” activities (now often legally incorrectly called “mobile banking”)? In my view it is high time we take a big step away from the comfy times where foreign donors and NGOs are shielded from criticism because of their good intentions. Especially when operating in financial markets they need to fully accept their responsibilities, even when that means that some donors threaten reconsidering their “commitments”.

What do you think?

Respectfully, Peter

BSD City, Indonesia, June 2010

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