What and Where is Micro-Finance? Between a rock and a soft place
microfinance focus

By Peter van Dijk,

Microfinance Focus, October 20, 2011: Despite all the current sometimes emotional debates on the lack of evidence on its impact and on a possible crisis, Micro-Finance (MF) has undergone a tremendous evolution in intellectual and practical terms. In practical terms Micro-Finance has evolved into a diverse multi-billion dollar industry. Intellectually, Micro-Finance has established itself firmly in the discussions on the highest global level (G8, G20, International Monetary Fund, World Bank, United Nations etc).

But what are we really talking about? When discussing microfinance even people in the same organisation seem to sometimes talk past each other instead of with each other. The body that came out of the World Donor Group on Micro-Enterprise Finance and Rural Finance in 1995 (1) , the Consultative Group to Assist the Poor, CGAP, seems to define Micro-Finance as “Building Local Financial Systems That Work for the Poor” but it stopped calling its strategy such, preferring the term “Strategic Directions” (2). CGAP’s former strategy was called “CGAP Phase III Strategy 2003-2008”. You might tell me that the title change is marginal and not important, but I am pretty sure that when you reflect on it a bit longer, you become as curious as I am to know why the world-wide coordinating and support organisation of Micro-Finance changed the title from “Strategy” to “Strategic Directions”. Is it because CGAP does not want to have an institutional strategy to which all its owners, management, supporters can be held accountable, or is it rather (as I guess) because there are so many “strategic directions that make sense of being promoted? What I do know is that most financiers, managers and consultants of Microfinance NGOs don’t feel part of one financial market as CGAP states, which is clearly regulated by the European Union by defining Microfinance as Micro-Credit under its Social Affairs Department (3).

The different CGAP’s “directions” are sufficiently vaguely defined to cover many different actors. Some strategic directions will influence others, frustrating or maybe even undermining the achievement of the strategic objective of one inclusive financial sector. And that is the main point of this article.

In the world of Micro-Finance many government bodies (including government departments and agencies as well as multi-lateral organisations such as UN, WB and IMF), donors and civic organisations (such as charities, individual philanthropists, NGOs, religious faith organisations) support many development activities that include Micro-Credit. Participating at many inter/national debates and publishing many articles and studies each month, including on the crises on high lending interest rates, high profits, double borrowing and potential borrower exploitation, they seem to embrace the term Financial Inclusion. However, when they started, many organisations that undertake or support Micro-Credit showed enthusiastic commitment for having found an escape for their frustration of banks, bankers and the macro-economists who dominate global discussions on the building up of economies, which influences their societies. Is that expression of frustration not similar to what we now see on the streets of the USA and in some European countries? Many citizens want to hold these bankers and macro-economists responsible for the slow-down and social divide in these two regions that so far dominated the world.

And here I touch upon two extremely sensitive as well as very important points.

First, we can all again easily identify the progress that Micro-Finance in all its possible forms and aspects made over the last decade(s). I dare say that we can speak about a new kind of science that has developed. But what science are we talking about? Science is defined by verification of empirical evidence; so what are the objectives, assumptions, sensible consequences and performance signals that need to be monitored, studied and interpreted in Micro-Finance? And who will be responsible for this science?

All supporters of microfinance believe that it is a service that should aim to make a positive impact on the lives of poor people. When some criticise commercial banking in the one “extreme” and informal moneylenders in the other, they argue that microfinance should not be an excuse to over-indebt clients or charge exorbitant interest rates. They say that “MFIs shouldn't just push money out the door without adequately understanding the needs of the clients and trying to meet those needs. In that sense, yes, we have a social orientation”. At the same time, these microfinance supporters do not mean to say that they view MF as “charity” or that MFIs should provide non-financial (social) services to the detriment of their profitability (4). Recently, “Social Performance Measurement” (5) has been integrated into many Micro-Finance Institutions, but without losing sight of financial performance and the objective of ensuring financial viability of MF partners, even if they choose to offer financial education or other non-financial services to their clients.

Many original socio-political micro-credit supporters continuously, strongly and completely believe in sustainable MF, but try to ensure that partner MFIs stick to their poverty alleviation mission and track it as they commercialize. They chose to walk a thin line that proves vulnerable to critics from the social as well as the commercial side. In my view it might be preferable and easier to explain to have a strategy of diversifying markets in terms of clients, products and regions. A diversifying (Micro-) financial institution can, at the same time, show that it accompanies clients out of poverty, extends into areas banks would not venture before and that it even can hold non-poor clients that are proud of being a client of a banking organisation that is excellent in banking and as well as showing its commitment for the entire local community and its future.

The “scientific activities” of measuring MF activities; the scientific insight that commercial sustainability can be connected to responding to the financial needs and to the consumer rights of the poor, has brought social micro-lenders closer to the formal financial sector, closer to the bankers they feel so “emotionally troubled” about. And this produces the second sensitive issue.

Many Micro-Credit NGOs have requested their country’s authorities as well as their supporters to assist and accompany them in their transformation into formal, professional financial institutions. Such formalisation means regulation by finance ministry and supervision (and secondary regulation) by the central bank (6). This is the case in Cambodia, Palestine, Nigeria, Uganda, the West African UEMOA region, and Vietnam as I worked as a legal advisor with the central banks and MF associations in these countries. And it surely happens/-ed in other countries. Such transformation would then also result in the possibility of collecting and on-lending voluntary deposits (7) of the general public.

Safeguarding deposits (and stabilising and transforming deposits into savings) has been found in many countries to be the financial services that poor people need first and most. This was often a surprise for experts from different sides who shared the popular belief that “the poor are too poor to save”. I remember that in several countries the central bank’s Supervision Director amicably took my shoulder and said, in an attempt to relax my enthusiasm on deposit-led microfinance: “Peter you need to understand that whatever you learned in so many other countries, people here are different, culture here is different and the poor here are really too poor to save”.

Secondly, voluntary deposits (and savings) of the customers is most often a cheaper (8) and more stable source of funding than “buying” (in the form of borrowing or investments) or receiving funds in the form of total or partial grants and/or subsidies (9). Thirdly and equally very important, the voluntary information that clients provide when dealing with their money (deposits, savings, payments, transfers, maybe investments) also holds reliable and freely gathered data that also is relevant for estimating credit risk (of the potential borrower). And finally when collecting and managing customers’ money, micro-lenders that in many countries delegate money management to commercial banks, learn as (micro-) financial institutions the skills and challenges of cash money management and transport, a fundamental skill of banking organisations which also demonstrates their integrity and reliability.

The professionalization and transformation of Micro-Credit NGOs into financial institutions, undertaking banking (“Bank-like”) activities and especially deposit-taking and cash money handling requires these organisations to be regulated by financial authorities whose expertise is banking. This leads to confrontations of two different cultures which can culminate in conflicts of which poor, unbanked citizens fall victim. It is not uncommon that recently regulated MFIs defend themselves against weaknesses identified by regulatory authorities that “they are not bankers”, “that they help the poor”. It can go as far as to accuse bankers and their authorities of being immoral or even being thieves. This clearly comes from a “holy” taboo, the emancipation of banking, on discussing what professionalization, commercialisation, deposit-mobilisation, money- handling and banking regulation mean.

For instance, MFIs that are housed in the buildings of NGOs that also provide other non-financial activities, social activities, cultural, education etcetera, should be able to understand that their financial activities require a separated building with specific staffs who are trained, paid for their “fit & proper” character and skills and who will be held legally and financially liable for mistakes. But some religious, cultural and humanitarian NGOs that undertake micro-lending for a long time, world-wide and on a considerable scale, insist with central bankers that it is unreasonable to demand that the MFIs need to leave the NGO buildings when they want to undertake “micro-finance banking” as a core business activity. Why? To avoid expensive investments or risk acquiring the image of having become a banker?

I think it ultimately harmful for the poor if Licensed Micro-finance is seen as an opportunity to show the world that an organisation undertakes MF “as a banker without being one”; that is ambiguous and in fact a contradiction. And micro-finance banking cannot just be learned on the way of evolution or in some days on a seminar.  It is, consequently, difficult to understand why managers in some regional development banks and in multi-lateral development organisations prefer recruiting people with Micro-Credit NGO background to work on financial inclusion, including regulation. Bankers and banking authorities definitely need to learn about micro-finance and its social dimension but socio-political micro-lenders also need to learn, understand, support and integrate banking principles. Mrs. Eva Mukasa, founder and director of Ugandan Women Microfinance Trust once said that she really protected her clients’ interest when she ended being an anthropologist and became a banker.

This brings me to my conclusion. I am convinced that people who want to integrate Micro-Finance into the regulated banking sector need to fully understand, endorse, live and promote banking principles. That does not at all mean softening the commitment towards poor, unbanked people, ON THE CONTRARY, it will strengthen banking in a period that it most needs such improvement. Micro-credit within the social welfare system is immensely important, as now is organised in the European Union and its Member States, but it needs to be firewalled from building inclusive financial sectors. Bringing to two together will undermine financial sector development as facts and studies the world over since the 1900-s show, as a blow of a fist to a weak underbelly.

(1) Which was co-chaired by the World Bank and the European Union and in which many national and multilateral agencies participated that now support CGAP.
(2) STRATEGIC DIRECTIONS 2008–2013, Building Local Financial Systems That Work for the Poor: Equity and Efficiency (CGAP 2008).
(3) JASMINE (European Commission Initiative to reinforce development of micro-credit in Europe) is an initiative which seeks to improve access to finance for small businesses and for socially excluded people, also ethnic minorities, who want to become self-employed, see www.ec.europa.eu.
(4) Although many micro-credit supporters and promoters make efforts to avoid the term “profit”, preferring terms such as sustainability or cost-covering. The jargon of the macro-economists makes it difficult for them to avoid the term profit when making scientific explanations on the importance of micro-credit and Micro-Finance Institutions.
(5) SPM, also defined as Social Performance Management, which in my opinion assumes that all stakeholders in an MFI would be concretely responsible in case of weakness, but such (legal or financial) liability is avoided through “Voluntary Codes” by many clever MFI owners, managers and “social investors”.
(6) Or specialized banking supervisory authorities (such as the “Superintendencias” in many Latin American countries, or the discussion of specific agencies, apart from central bank in several countries, such as in Indonesia.
(7) Please make a careful distinction with the term “savings”. Poor people are distrustful of banking institutions (and often embarrassed) and they have to manage many crises on a daily basis that means that their money needs to be withdrawn on a fast and flexible basis. Saving is a focused activity and behavior of setting aside money for a specific purpose over a longer period of time. The period needs to be agreed as a “fixed term” with the banking institution (by the way a regulated MFI is by law often a “banking” institution but not a “bank”, another important legal distinction), as well as the withdrawal conditions and the remuneration (interest rate, or maybe other forms as might be discussed under “Islamic finance”; by the way, Jewish and Christian religion, read the book Deuteronomy, also hold lending prohibitions and fixed interest rates, the Pope softening its stance in the 17th century after Henry VIII did).
(8) Depending on the operational (and legal) methodology and systems that are chosen, utilized and further developed.
(9) Several MFI managers state from their transformation experience that receiving subsidies and grants in end effect turned out to be more expensive in financial terms (including ownership and management influence that donors think they “buy”).
(Disclaimer: Views expressed in the article by the author is his own and do not necessarily represent those of Microfinance Focus)


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