Frequently asked questions
Inclusive finance encompasses the supply of a broad range of basic financial services, such as microfinance, directed at clients that are beyond the reach of traditional channels and products. These clients can range from small entrepreneurs in developing countries to small and medium enterprises (SME) in emerging markets that lack access to financial services. Appropriate financial services can encourage small enterprise activities and improve the standard of living of households.
Microfinance is the supply of loans, savings, and other basic financial services to the poor. People living in poverty, like everyone else, need a diverse range of financial instruments to run their businesses, build assets, stabilize consumption, and shield themselves against risks. Financial services needed by the poor include working capital loans, consumer credit, savings, pensions, insurance, and money transfer services.
The poor rarely access services through the formal financial sector. They address their need for financial services through a variety of financial relationships, mostly informal. Credit is available from informal commercial and non-commercial money-lenders but usually at a very high cost to borrowers.
Savings services are available through a variety of informal relationships like savings clubs, rotating savings and credit associations, and mutual insurance societies that have a tendency to be erratic and insecure. Traditionally, banks have not considered poor people to be a viable market.
Providers of financial services to the poor include donor-supported, non-profit non-government organizations (NGOs), cooperatives; community-based development institutions like self-help groups and credit unions; commercial and state banks; insurance and credit card companies; wire services; post offices; and other points of sale. NGOs and other non-bank financial institutions have led the way in developing workable credit methodologies for the poor and reaching out to large numbers of the poor.
A microfinance institution (MFI) is an organization that provides financial services to the poor. This very broad definition includes a wide range of providers that vary in their legal structure, mission, and methodology. However, all share the common characteristic of providing financial services to clients who are poorer and more vulnerable than traditional bank clients. MFIs are those that are subject not only to general laws but also to specific banking regulation and supervision (development banks, savings and postal banks, commercial banks, and non-bank financial intermediaries).
Microfinance clients are often described according to their poverty level - vulnerable non-poor, upper poor, poor, very poor. This can obscure the fact that microfinance clients are a diverse group of people - and require diverse products. While women clients make up a majority of clients - and in some instances comprise 100 percent of an MFI's clientele, 33 percent of all microfinance clients are men. From experience MFIs have learnt that women have better repayment rates than men.
MFI clients operate small businesses, work on small farms, or work for themselves or others in a variety of businesses - fishing, carpentry, vegetable selling, small shops, transportation, and much more. Some of these microfinance clients are truly entrepreneurs - they enjoy creating and running their own businesses. Others become entrepreneurs by necessity when there are few jobs available in the formal sector. All over the world about 190 million people make use a form of microfinance. Yet another 2.7 billion people – of which 1.2 billion are living under $1.25 a day - are excluded from any financial service.
[Source ING/NPM ‘A billion to gain’]
Poor people, with access to savings, credit, insurance, and other financial services, are more resilient and better able to cope with the everyday crises they face. Even the most rigorous econometric studies have demonstrated that microfinance can smooth consumption levels and significantly reduce the need to sell assets to meet basic needs.
Access to credit allows poor people to take advantage of economic opportunities. While increased earnings are by no means automatic, clients have overwhelmingly demonstrated that reliable sources of credit provide a fundamental basis for planning and expanding business activities. Many studies show that clients who join and stay in programs have better economic conditions than non-clients, suggesting that programs contribute to these improvements. A few studies have also shown that over a long period of time many clients do actually graduate out of poverty.
Financial services allow poor households to make the transformation from "every-day survival" to "planning for the future." Households are able to send more children to school for longer periods and to make greater investments in their children's education. Increased earnings from financial services lead to better nutrition and better living conditions, which translates into a lower incidence of illness. Increased earnings also mean that clients may seek out and pay for health care services when needed, rather than go without or wait until their health seriously deteriorates.
Whether or not financial services lift people out of poverty, they are vital tools in helping them to cope with poverty. The poor use credit and savings not only to smooth consumption, but also to deal with emergencies like health problems and to accumulate the larger sums they need to seize opportunities (occasionally including business opportunities) and pay for big-ticket expenses like education, weddings, or funerals.
In general microfinance can contribute to the UN Millennium Development Goals (MDGs). The MDGs commit the international community to a common vision of development-one in which human development and poverty reduction have the highest priority. The objective of the MDGs is to serve as guideposts and focus the efforts of the world community on achieving significant, measurable improvements in poor people's lives. The goals grew out of the agreements and resolutions of various development conferences organized by the UN in the 1990s.
Microfinance, or financial services for the poor, can be, and must be profitable. At the same time, some worry that an excessive concern for profit in microfinance will lead MFIs away from poor clients to serve better-off clients who want larger loans. It is true that programs serving very poor clients are somewhat less profitable than those reaching better-off clients, but this may say more about managers' objectives than an inherent conflict between serving the very poor and profitability. MFIs serving the very poor are showing rapid financial improvement.
However, there are cases where microfinance cannot be made profitable, for example, where potential clients are extremely poor and risk-averse or live in remote areas with very low population density. In such settings, microfinance may require continuing subsidies. Whether microfinance is the best use of these subsidies will depend on evidence about its impact on the lives of these clients.
Not every person is a natural entrepreneur or merchant. Some people prefer to have a job that generates money. The microfinance sector is more and more focusing on the development of small and medium-sized enterprises (SMEs). Regular financial institutions like banks are less interested in financing SMEs. MFIs don't have a suitable offer for these businesses and lack knowledge and expertise to serve them. Therefore MFIs can't come along with their professionalizing clients.
While many poor people can benefit from a microloan, not everyone wants or can use credit. To use credit effectively, clients must be able to generate income at a rate higher than the interest they are paying. Providing credit to those not able to use it productively could push already-vulnerable people into debt.
So what other services are available beyond credit? Savings services can benefit most people, if their
savings are safe. Secure savings facilities provide a means to reduce vulnerability by allowing households to better manage their risk and cash flow. Savings are an affordable way for poor families to accumulate money that can be used for investment. Often, microfinance institutions may first need to transition to a regulated legal form in order to be allowed to offer deposits to the public.
Other financial services, such as remittances, insurance and pensions, are often sorely needed by poor people. For example, remittances are a significant source of income for many poor people. Enabling cheaper, faster money transfer services would be a great benefit for many poor families who currently spend significant percentages of their earnings to move money. Moreover, many families could utilize insurance products and better pension delivery systems for greater social protection.
MFIs have to charge rates that are higher than normal banking rates to cover their costs and keep the service available. Acquiring funds for an MFI is more expensive than for a normal bank, for example. But even the rates charged by MFIs are far below what poor people routinely pay to village money-lenders and other informal sources, whose percentage interest rates routinely rise into the hundreds and even the thousands. The fact that interest rates are acceptable to MFI clients, shows in the high repayment rates. Worldwide it is estimates that 97 to 99 percent of all microloans are repaid.
This does not mean that all high interest charges by MFIs are justifiable. Sometimes MFIs are not
aggressive enough in containing transaction costs. The result is that they pass on unnecessarily high transaction costs to their borrowers. Sustainability should be pursued by cutting costs as much as possible, not just by raising interest rates to whatever the market will bear.
Interest rates, while still too high in some places, are dropping on average 2.3 percent a year. The
microfinance industry has placed a lot of emphasis on improving efficiency in order to bring down these costs, so that poor clients are not paying unnecessarily high rates. New technology also offers to help reduce costs, so rates are expected to continue to drop as institutions become increasingly efficient at delivering services to poor people.
Some countries impose legal caps on interest rates, hoping to protect borrowers. But when government imposes a cap, it is politically difficult to set the cap high enough to cover the administrative costs of tiny loans. The result tends to be that smaller (and poorer) borrowers can't get loans, because no one can provide them without losing money.
For more information about the elements determing interest rates in microfinance, click here.
For a while one was under the impression that poor people didn’t have money to save. Moreover they have limited access to deposit services offered by formal or semi-formal institutions.
The consequence of the scarce availability of appropriate savings services is that most poor people save in informal ways - by tucking cash under the mattress, buying animals or jewelry that can be sold off later, joining village savings circles, or giving money to neighbors for safekeeping. These methods of saving are very risky - cash can be stolen, animals can get sick, the neighbor can run off with it.
Institutions that want to offer saving services or micro insurances, need to have a license. To obtain
this license, a financial institution should have some scale or assets. To reach scale, MFIs could merge. Donors that fund MFIs have committed themselves to address the needs of the poor and very poor. Whether scaling up of MFIs contributes in this way can be questioned.
For a credit-based institution, managing the shift to being a full-fledged financial intermediary is a complex challenge, bigger than simply developing new products and adapting some management systems.
The transformation to a full financial intermediary fundamentally changes a financial institution. Some of the biggest challenges include attracting an adequate volume of deposits, managing operating costs and developing trust among clients. To gain trust, a financial institution will need to consciously develop staff, quality of service and a consistent brand image in the market. To safeguard the savings of depositors, a board or other governance body must exercise reasonable oversight, ensure sufficient discipline, and serve as a check on management performance.
Donors can help develop sound savings operations by for example helping to strengthen regulation and supervision, improving regulators' understanding of microfinance issues (such as the high volume of small-value transactions, alternative collateral and interest rate policy), providing technical assistance grants and funding savings-focused market research.
Governments play a variety of roles in promoting improved access to financial services and improved quality from providers. Some roles - such as overseer and developer of the financial infrastructure (such as payments or credit information systems) and maintainer of macroeconomic stability - are often very supportive of an inclusive financial sector.
Governments have an important role to play as protector of financial consumers. A number of recent forces - including new services, technology, delivery channels, providers, and investors - have raised the profile and urgency of consumer protection issues in microfinance. The overall challenge is to ensure that clients can make informed choices, products are designed to work for both the user and the provider, and mutual rights and obligations are understood and respected.
At a local level regulations can be important. Yet, developing trade organizations and credit control is necessary to prevent over-indebtedness.
Food security is depending on economic development in rural areas, where the majority of people is living. The costs of rural finance are relatively high because of the low density of the population. Furthermore, many potential clients are difficult to reach because of poor infrastructure.
Rural and agricultural finance clients are a complex and overlapping blend of rural households, small farmers, agribusinesses, and off-farm enterprises. The main source of credit for many farmers and agribusinesses is other agribusinesses along the value chain including input suppliers, traders, and processors. Moreover, the clients’ own savings and credit from financial institutions (varying from banks to agricultural cooperatives) continues to play a role in agricultural production.
MFIs generally lack knowledge of the risks accompanying agricultural activities and are less represented in rural areas. Risks could be bad weather conditions, volatile prices and crop failure. At the same time a poor infrastructure or social differentiation can be an obstacle for rural finance.
All over the world about 190 million people make use a form of microfinance. The sector has grown rapidly. This expansion has led to professionalization as well as relatively high interest rates and over-indebtedness of clients. Moreover the growth comes along with attracting commercial funds. Commercial investors are needed but there is a clear risk that MFIs shift their focus to the return of assets instead of protecting the interests of their clients.
Donors as well as investors agree that the client should be at the center of their attention. Several initiatives and campaigns contribute to this ambition:
- Investor principles
In January 2011 about 40 companies and organizations signed the Seven Investor Principles for responsible and sustainable microfinance in The Hague. The principles concern among other things client protection, fair treatment and a common interest rate.
- Social performance
The members of NPM agreed to abstain from cooperation with institutions that exclusively aim at profits. They initiated the founding of the Social Performance Task Force (SPTF), that develops, promotes and spreads accounting standards and good practices. SPTF aims to strengthen a socio-ethical policy and management within MFIs.
- Microfinance Information Exchange
The Microfinance Information Exchange (MIX) is a rich source of information about microfinance. Recently MIX started to publish reports on social performance indicators.
- Client Protection Principles
MFIs, donors and investors all over the world have endorsed the Client Protection Principles. By this an institution states that it is willing to protect clients in different ways. For example by setting pricing, terms and conditions in a way that is affordable to clients, by monitoring internal systems that support prevention of overindebtedness, by organizing responsive mechanisms for complaints and problem resolution for their client.
- Microfinance Transparency
The microfinance sector persists in pursuing lower interest rates. Microfinance Transparency makes interest rates in countries transparent. As a consequence the average interest rates decrease.
For more information and initiatives see: Challenges and Initiatives
- Investor principles