Tag Archives: microfinance

Strengthening Economic Freedom through Microfinance

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Providing the poor with access to credit at reasonable interest rates does seem to be a panacea for alleviating poverty. With credit, a person can produce a good or provide a service that will generate an income with which basic needs can be met. Credit also allows a person to utilize their talents, skills, and initiative to fill a niche in the market, spurring economic and entrepreneurial growth in a community and country. In rural Guatemala, for example, a woman bakes bread every morning in a stove bought with a small loan and sells the loaves to a shop in her village. In Nepal, a man buys five water buffalo with a small loan and sells the milk each morning to his neighbors.

Though it is difficult to estimate the affect of such micro-entrepreneurial activities on a country’s overall GDP, the impact on individuals and society is immeasurable. Small loans stimulate private entrepreneurship and expand economic freedoms crucial to building a market economy and democracy. They empower the poor with the freedom to make choices regarding how they use and save their income. If spent on food, health care, shelter and education, individuals can more easily escape the poverty trap. Raising the income level and standard of living among the world’s poor also builds a middle-income class that is more able to participate in civic activities and demand greater accountability from the government.

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Can microfinance ignite a good governance epidemic?

Afghan people walk past a Kabul Bank branch in Kabul, September 14, 2010. (Photo: Reuters/Andrew Biraj)

In The Tipping Point, Malcolm Gladwell called them ‘connectors’. The growth of social media has popularized the established marketing term for them: influencers. They’re the highly connected hubs in any network that play a key role in spreading information, ideas, practices, and even diseases. Banks, for example, are economic hubs. If only they took that role more seriously.

This week the Afghan government announced it is dissolving Kabul Bank, the country’s largest and the government’s sole financial services provider, because Kabul Bank executives and board members were using savings deposits as a personal slush fund rather than extending loans and credit on a commercial basis. Kabul Bank officials disbursed $850 million in fraudulent loans to major shareholders and political allies, representing 94 percent of all Kabul Bank lending, The Wall Street Journal reported.

If you think that sounds terrible consider China’s estimated $1.2 trillion loaned to local state-owned enterprises for mostly political rather than commercial purposes. Seeking ways to save, lend and seek investors more efficiently, China’s burgeoning middle class is creating a massive shadow financial sector, according to a recent Financial Times report.

In the United States, the subprime mortgage crisis continues with no end in sight, as banks recently began to unravel the mortgage bundles underlying the asset-backed securities at the heart of the crisis. In order to satisfy court procedures for repossession, banks have been submitting forged materials from factory-style document farms, as reported recently on 60 Minutes.

With such economic hubs at their core, whether in Afghanistan or China or elsewhere, it’s no wonder that corruption – by anyone’s definition – seems so intractable. But the story of banks as economic hubs doesn’t always have to be a tragedy. In the aftermath of the East Asian Financial Crisis in 1997, one financial sub-sector realized the importance of taking their hub status seriously: development finance institutions.

Created after World War II, development finance institutions in East Asia started out as channels for administering reconstruction loans and overseeing project management. Though they’ve since evolved in different ways to fund nascent and growing economic sectors ahead of other investors, development finance institutions remain heavily involved in improving client management and governance.

After the 1997 East Asian Financial Crisis, development finance institutions in East Asia knew that they needed to restore investor confidence and get economies back on the market-oriented growth path that has reduced more poverty than in any other region in the world. Led by the Association of Development Finance Institutions in Asia and the Pacific (ADFIAP), their collective response was to strengthen corporate governance in the region, starting with themselves.

With a collectively-built corporate governance rating system, region-specific training materials and the ADFIAP-housed Institute for Development Financing to support and conduct regular risk management and governance seminars for staff and board members (more info on www.governance-asia.com), development finance institutions got themselves on track to strengthen corporate governance in the region by serving as the standard to which they held their client networks accountable.

After the Andhra Pradesh crisis, its largest to date, can microfinance follow in the footsteps of development finance institutions? Though not inclusive of all microfinance providers, there are about $26.9 billion in deposits and $65 billion in loans on the balance sheets of the 1,933 microfinance institutions reporting to the Microfinance Information Exchange as of writing this post – and those numbers have been growing about 20 percent a year. Microfinance providers are thus emerging as new economic hubs.

By serving as examples of effective corporate governance, microfinance providers could succeed where so many financial institutions have repeatedly failed, and in so doing could ‘infect’ their client and community networks with the ‘disease’ of strong corporate governance. With almost three billion unbanked people still to reach, those are huge potential networks to infect.

Such an epidemic would be good for reducing poverty, as it would serve to attract investment into new and growing businesses. It would be good for financial sectors around the world trying to end the succession of financial scandals and crises. It also would be good for new or struggling democratic states, once more transparent financial sectors within countries take over development financing from international institutions.

If they got their corporate governance act together, microfinance providers could ignite a good governance epidemic. But that’s a big if.

For a deeper look at corporate governance and microfinance, check out “Corporate Governance, Scale, and Financial Inclusion,” by Oscar Abello for CIPE’s Economic Reform Feature Service.

Banking on governance

There are always losers when banks make poor lending decisions. Unfortunately, those losers often extend beyond the banks themselves, whether we’re talking about state-owned banks in China, banks that are essentially donor-backed in Afghanistan, or microfinance banks in India.

In China, the losers are middle class citizens who do not have much choice when deciding where to keep their savings – the Chinese government controls most of its financial sector.

Seeking projects that will increase their prestige and lead to promotions, political leaders direct bankers to invest in inefficient and financially leaky state-owned enterprises that build railroads, highways, and airports that do not deliver high rates of returns. Needless to say, many of these loans are never repaid. All the while, the government’s near-monopoly of the financial sector provides a constant stream of cheap funds from middle class depositors

In Afghanistan, Kabul Bank – the country’s largest financial institution – has recently caused a scandal for making $900 million in bad loans, some of which has simply disappeared. While there are some borrowers who have agreed to modest repayment schedules, many have not and others dispute the full amount of their loans to be repaid. There are even loans that were granted without paperwork to unknown or anonymous borrowers.

Unlike Chinese banks whose deposits come from citizens, Kabul Bank’s largest depositor is the Afghan government itself, which is largely funded by donors such as the United States government. What’s also unfortunate is that some of the money seems to have disappeared with Afghani elites, making it even more difficult for Afghanistan’s Central Bank to get any of the money back.

Microfinance institutions in India face their own unique lending challenges. Owing in part donor-driven programs as well as the Priority Sector Lending Act, which directed 40 percent of domestic lending into 14 “priority sectors” including microfinance, capital has practically overwhelmed Indian microfinance institutions (MFIs). In this Economic Reform Feature Services article, CIPE’s Oscar Abello argues that, “Pressure to extend loans out of kindness or to meet quarterly portfolio targets are a tremendous temptation to circumvent checks and balances in the loan approval process – assuming checks and balances exist at all.”

Given that in India’s Andhra Pradesh state outstanding microloans grew from one million in 2005 to 25-27 million in 2010, valued at $4 billion, did this pressure lead to Andhra Pradesh’s microfinance crisis in which bank customers were “exploited by private microfinance institutions through coercive means of recovery resulting in their impoverishment and in some cases leading to suicides”?

Banks of every size are vulnerable to governance challenges. As microfinance grows to include populations that are already vulnerable to the ups and downs of poverty, can microfinance institutions implement good business practices where other banks have failed? If so, there are important implications for financial inclusion, SME access to finance, and democracy. In this article, Abello details how: greater attention to corporate governance.

Article at a glance:

  • An estimated three billion people around the world have limited or no access to formal financial services. Such financial alienation leads to social and political alienation, which undermines democratic development.
  • In order to be effective in improving access to finance for the poor, microfinance institutions (MFIs) must better manage key risks they face, including client credit risk, industry reputation, competition, and governance.
  • Better corporate governance can make the operations of MFIs – both profit and non-profit – more sustainable and more scalable, and have a multiplier effect of increasing transparency and inclusiveness beyond the financial sector.

Read the full article here: http://www.cipe.org/publications/fs/pdf/033111.pdf

On profits and progress

A front page story in today’s New York Times details how large banks are profiting from serving a majority of microfinance clients, fueling debates about the high interest rates they charge to poor borrowers. Longtime microfinance proponents remain steadfast that high micro-borrowing rates put investors’ interests ahead of the poor. From a broader perspective, others argue, it’s not only investors who profit from high interest rates; the poor also profit from the expansion of commerce, and in the process sow the seeds of true social progress.

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The intermediary imperative

Egyptian Spice Vendor

Perhaps this Egyptian street vendor can now get a loan. Could he also have need for a bank? (http://www.flickr.com/photos/stager57/2219225055/)

This month the World Bank loaned $300 million to the Egyptian government to pass on as loans to Egyptian micro- and small- enterprises (MSEs). Aside from the fact that bureaucrats may seek kickbacks or play favorites when disbursing loans, the move calls into question the role of donor organizations in private sector investment. Should they provide capital directly, which may encourage unsustainable donor dependency? Or should they help build capacity to enable financial intermediaries, who have a long history of providing capital and financial services to clients of all demographics?

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CIPE Roundtable on Microfinance Outreach continues to reap impact

As a result of CIPE microfinance stakeholders’ advocacy initiative in August 2007, the State Bank of Pakistan introduced a new policy for microfinance banks in August 2008. The new policy incorporated 80 percent of recommendations from the private sector. These recommendations focused on two issues: a) increase in the outreach of microfinance, b) reduction of the cost of borrowing.

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Policy Changes Help Improve the Microfinance Numbers in Pakistan

The recent issue of Microwatch, a quarterly publication from Pakistan Microfinance Network suggests that “after a dismal conclusion to the past year, 2009 started on an encouraging note with microcredit growth in positive figures at the end of first quarter.”

CEO of Small and Medium Enterprise Development Authority (SMEDA), Mr Shahid Rasid, also spoke about the need for banking sector to come forward with help in SME sector development. He said:

    “The mounting task of SME development cannot be accomplished without sincere cooperation of the banking industry in the country.”

Since availability of microfinance to small businesses could be one of the ways to address the issue of lack of financing, State Bank of Pakistan (SBP) set a target to increase the outreach of borrowers from 1.2 million to 2.5 million by the year 2010.
CIPE organized a business policy roundtable in August 2007. The roundtable was attended by 75 representatives of the banking and financial industry, business, and international organizations. SBP agreed to move all finalized recommendations through a review process and develop an appropriate implementation plan.

Following that, SBP organized a consultative group and included CIPE as a member. Based on roundtable recommendations, the consultative group advised SBP on key policy issues that were hampering the growth of microfinance sector. Last year, these efforts resulted in SBP adapting 80 percent private sector recommendations in the microfinance policy announced in 2008.