Decision tools for rural finance
1.1 What is specific about agricultural finance?
The financing of agricultural activities reflects specific characteristics and constraints – factors that explain the difficulty microfinance institutions have in meeting this demand.
Family farms need to innovate, modernize and improve their productivity constantly. Their financial needs, therefore, involve various types of loans, both shorter and longer term:
- short-term loans to finance the crop year (inputs, labour, fattening on pasture, storage, initial processing of agricultural products, etc.); and
- medium-term loans for farm equipment.
The demand for loans can be considerable. The characteristics of this demand (type of service, amounts, loan repayment schedules, types of guarantees available, etc.) are extremely diverse and vary according to the agro-ecological zone; the degree of diversity and intensity of production systems; the type of stakeholders (men, women, youths establishing their own farms, agricultural entrepreneurs, farmer organizations, etc.); and the degree of market integration (see Appendix 1).
The financing of agriculture is characterized by a high level of risk, both climatic and economic (price fluctuations, difficulty in selling harvests, etc.). These risks are often covariant, in that they affect all borrowers in a given zone at the same time (drought, floods, epizootic diseases, etc.). Covariant risks are therefore harder to manage through the usual mechanism used in microfinance to secure loans, that of solidarity groups. All these constraints are intense in the areas where IFAD is typically present, namely disadvantaged areas without staple food crops and where infrastructure and markets are often underdeveloped.
Another factor differentiating agricultural finance is that farm budgets are closely integrated with household budgets, and financing for agricultural and non-agricultural activities, consumption and household investments are closely linked. Among a household's various economic activities, agricultural activities are often less profitable and more risky than non-agricultural activities.
In most countries, agricultural finance has mainly focused on export crops. The liberalization of agricultural economies has led to a reduction in the amount of credit available for agriculture, and microfinance institutions have often been called upon to fill the gap.
Financial services for farming households also need to include not only savings products that allow farming households to develop their farms' self-financing capabilities, but also simple insurance services.
1.2 What Does Microfinance Contribute to Agricultural Finance Today?
Contrary to preconceived notions, microfinance, in all its diversity, already contributes substantially to the financing of agricultural activities (see Appendix 2). Nevertheless, this contribution remains largely insufficient compared with the volume and diversity of agricultural financing needs in the current context of liberalization of farm economies in developing countries.
Microfinance loans are mostly short term, while the supply of medium- and long-term loans is generally insufficient to meet demand. There are several reasons for this shortfall, including that the profitability of the activities financed may be insufficient to cover the cost of the loan (for example, this is often the case with purchase of animal traction in staple crop farming); microfinance institutions (MFIs) lack access to stable medium- and long-term funds and prefer to secure a return on their funds through rapid rotation as short-term loans; and MFIs do not have the appropriate technology to track and support medium- and long-term loans. Yet, innovations are being introduced, such as mutualist rent-to-own systems and equipment loans guaranteed within production sectors (see Appendix 3).
No one MFI model is better suited to agricultural lending than any other, but systems that foster feelings of ownership among their members (such as credit unions (CUs), cooperatives and village banks) enjoy a higher success rate than others, and contribute most strongly to agricultural financing. This derives from closeness to their members. A number of CUs and cooperatives were created by farming populations in order to meet their financing needs (e.g. Federation of Agricultural Savings and Credit Unions in Benin; Kafo Jiginew in Mali), and the decentralized loan disbursement and monitoring procedures make it possible to know borrowers well and treat applications individually. However, such MFIs, especially when they are small and very local, remain highly vulnerable to covariant risks. Conversely, entrepreneurial MFIs are less present in the agricultural field.
Certain innovations in securing agricultural loans seem promising, including agricultural warrants, loan delegation, jointly managed guarantee funds and mutual guarantee associations. These security mechanisms make use of new types of contracts between the various partners in agricultural activities: producers, farmer organizations, processors, traders, etc.
Today, microfinance experiments that significantly finance agriculture tend to be concentrated on production in secure areas (often irrigated areas). Some services developed to meet agricultural finance needs have been successfully provided by MFIs. However, they are usually focused on specific activities that bring strong added value to producers, and are being used in contexts where the predictability of incomes derived from such agricultural activities is quite high (cash crops in irrigated areas). For example, post-harvest credit provided by CU networks in Madagascar has helped producers to almost double the value of their crop by enabling them to store it for sale three to four months after the harvest season. Due to the profitability of this service to their clientele, those CUs have been able to provide this financial service at market cost (including the refinancing costs from local commercial banks, plus the operating margin of the CU and loan provision). This is one example of a very profitable agricultural microfinance service provided by CUs operating in rural areas, which brings strong value to their clients.
The issue of agricultural finance has also been raised to meet needs in staple crop production areas. In those areas, the basic rule should be to focus on the overall funding needs of the many household activities (which permits more effective risk mitigation) and not to fund only specific agricultural investments, due to the risks involved. This rural finance approach is also more likely to meet the needs of the rural poor, as it enables them to use microfinance services flexibly, helping to diversify their sources of income and cope better with adverse circumstances.
In general, agricultural finance could be developed by MFIs on a larger scale only if farming itself became a more profitable and safer economic activity. Beyond the need for certain predictability regarding the income generated from the agricultural activity (e.g. the need to be cautious in funding staple production in rainfed areas), it is also important to assess the safeguards that exist for the economic activities themselves, such as price policies and organization of markets and producers. Taking the same example of the CUs in Madagascar, very wide fluctuations in the price of rice have occurred there, due in large part to massive imports from Asia in recent years. The absence of a strong national market and producer associations, combined with loose import policies, have made the funding of rice production by CU networks much more risky for the farmers. To mitigate risk implies coordinating policies and donor actions, as well as forging new alliances between the various rural stakeholders, including farmer organizations, MFIs and support services.
1.3 Recommendations for Increasing the Microfinance Institution Contribution to Agricultural Finance
A number of steps can be taken to improve both the quantity and quality of financial services to the agricultural sector.
1.3.1 Meet solvent demand
The general recommendation to "meet solvent demand" is particularly appropriate in agricultural financing. Credit can only provide effective economic leverage if the activities financed are profitable. Credit should be used very prudently (and alternative interventions considered) in areas where agriculture is based exclusively on staple food crops, with rainfed practices, where market integration is low, and non-agricultural activities are not very well developed.
1.3.2 Improve the microfinance institution's knowledge of agricultural activities
As MFIs become more professional, they often hire specialized staff who lack detailed knowledge of the agricultural sector. To develop the appropriate financial services and adequate loan portfolio monitoring capabilities, detailed knowledge is needed of the characteristics and constraints of agricultural activities. This knowledge must include both technical aspects (production systems, farmers' practices, etc.) and a clear understanding of local economic and social realities. This knowledge then helps to identify the most suitable financial services, develop guarantee systems that are as effective as possible, and identify any potential for systemic failure.
In addition to the knowledge requirement, an information system is also needed to monitor changes in local agricultural activities. Creating and maintaining systems of this sort within MFIs can be costly. Contracting with other institutions active in the area (farmers' organizations, development programmes, support services, etc.) can provide more effective sharing of costs and further encourage exchange of information.
1.3.3 Diversify loan portfolios
MFIs that fund exclusively agricultural portfolios are extremely vulnerable to external shocks. Loan portfolio diversification strategies, therefore, need to be developed to mitigate this risk. A diversified credit portfolio and a wider range of products would, moreover:
- better match the actual needs of households, be they agricultural, rural, social, consumer or emergency in nature;
- provide real economic choice to producers, who can invest in the activities that are, in their opinion, the most profitable (thus increasing their sense of responsibility for their loans); and
- make it possible, above all, to spread risks over different agricultural production and rural activities, thus limiting to some extent the impact of covariant risks in agricultural production.
1.3.4 Support innovations on services and ways to secure loan portfolios
This implies that MFIs need to:
- develop adequate knowledge of their working environment;
- include their members in identifying and testing innovations;
- allow their staff and members access to information on innovations tested elsewhere. This will require undertaking study visits, facilitating Internet exchanges when possible, participating in networks, developing information centres on innovations for professional MFI associations, and promoting sector support programmes; and
- have the means in-house to innovate, including the right mix and number of staff, with pilot funding to design and test new products.
1.3.5 Develop ties with the formal financial system to gain access to the funding sources needed for agricultural financing
MFIs' own funds are often insufficient to cover agricultural needs. Links with the formal financial sector can provide specific solutions (improve the volume of funds available, the availability of long-term funds, etc.). This is highlighted in the example of Madagascar, where CU networks used commercial loans to fund post-harvest loan campaigns in favour of small-scale rice producers.
1.3.6 Disconnect financing from agricultural support and supervision
To a large extent, the failures of past agricultural financing systems can be attributed to the strong ties that existed between the two functions of funding and of agricultural technical support, encouraging lessened entrepreneur responsibility and a low level of specialized skills among MFI agents. Today, it is clearly acknowledged that MFIs should not provide agricultural support and supervision to their clients.
Technical support, however, can make agricultural loans more profitable for farmers and safer for MFIs. One approach is to seek to develop contractual relationships with other organizations active in rural areas and that could provide such support (support services, non-governmental organizations (NGOs), etc.).
1.3.7 Disconnect financing from farmer representation
This recommendation concerns more specifically MFIs that have emerged from the agricultural sector (CUs, cooperatives). Combining farmer representation with financial services can precipitate governance failings and management problems. Consensus is progressively building on the need to make the financial role autonomous through specialized institutions (MFIs) that are independent of the founding farmer organizations.
However, such autonomy raises the issue of a possible "financial mission drift" by the MFIs, away from the farmer organizations that initially created them. Innovations exist in this field to preserve farmers' representation in the supervision of MFIs: through representation on the Board of Directors, for example, using the college of administrators principle (see Appendix 4). Within such a supervision structure, however, it is important that a judicious balance be maintained between the representations of borrowers and of savers. Borrower domination may entail some risks, including practices that may benefit borrowers in the short term, while jeopardizing the MFI's longer-term sustainability (such as lower interest rates on loans, or larger loan amount compared with the saving requirement).
1.3.8 Strengthen ties between microfinance institutions and farmer organizations
Where MFIs do not grow directly from an agricultural environment, relationships between MFIs and farmer organizations can be marked by little mutual knowledge of each other's activities and roles, and a high level of distrust, with loan interest rates often focal points of contention.
Strengthening ties between these institutions – MFIs and farmer organizations – can help match services more closely to local needs and can improve loan security. Diverse approaches may be used: exchanges fostering better knowledge of each other and each others' approaches, use of MFI services by farmer organizations, joint participation in a credit bureau, etc.
Beyond the local level, ties should also be strengthened among the various bodies in charge of elaborating agricultural and financial policies.
1.4 Internet Resources for Further Reading
- Food and Agriculture Organization of the United Nations (FAO): Rural Finance (Marketing and Rural Finance Service)
- International Food Policy Research Institute (IFPRI)
- Natural Resources Institute (NRI)
2. Financial sector reform and the implications for rural finance programmes: the role of state-owned banks
2.1 IFAD and state-owned banks - current status
Most of the generic recommendations below will also apply to private commercial banks as potential partners for IFAD's rural finance programmes. However, they are not specifically mentioned here, since most private commercial banks in developing countries have limited branch networks in rural areas and so far have not been important partners for IFAD.
IFAD's experiences with state-owned banks with a mandate as commercial and agricultural development banks differ among the various regions. The Fund has moved away from state-owned banks in Eastern and Western Africa because of poor project performance and the closing of most of these institutions. In state-controlled environments, such as China, state-owned banks remain major partners within the rural context, where there is little alternative. In North Africa, the Near East and Latin America, cooperation still exists, but is progressively declining.
This general withdrawal from operations with state-owned banks on the part of IFAD, apart from very specific contexts, is understandable, as these banks in general have failed to reach the Fund's target groups in a sustainable manner. Subsidized credit has focused the supply of loans to well-off farmers, as borrowing conditions and collateral requirements have excluded the poor, and the type of services offered were frequently inappropriate to the needs of the rural poor. As a result, the IFAD's rural finance policy rightly argues against providing large credit lines to those institutions.
Despite these shortcomings, state-owned banks may, in principle, offer comparative advantages for reaching very large numbers of poor people in a cost-effective manner. These banks generally have large retail networks in rural areas, with trained staff, fund-transfer facilities and the ability to mobilize savings. Carefully designed pilot programmes for technical assistance and capacity building could help harness those comparative advantages, and reach the rural poor with financial services on a sustainable basis. Such pilot programmes will typically be based on the provision of technical assistance, and should not presume any large credit line (due to the reasons mentioned above, and since such a facility would have no added value and relevance in that context).
However, IFAD needs some guidelines for identifying the circumstances under which it might work with state-owned banks. The first step should be to recognize that the Fund does not usually have the capacity, political clout or mandate to support large-scale reforms of state-owned banks. The corporatist interests ingrained in these institutions, and their monopoly in providing funds and subsidies for the agricultural sector, make it unrealistic for a donor such as IFAD to be the prime partner or driving force for creating institutional changes in these banks. The World Bank may be better placed to assume this role.
Having said that, it may be possible to set up a ‘space' within state-owned banks where pilot experiences could be launched to test a new rural finance approach, based on sound microfinance practices. The key challenge, though, will be to attract the interest and support of senior bank management for piloting such approaches. Two steps will be needed:
- First, assess the overall institutional and financial status of the state-owned bank. It is important to have an overview of its financial and strategic status before deciding even on a pilot programme. Some state-owned banks may be on the verge of closing down, or in the process of being totally restructured. They may be facing institutional and financial problems of such magnitude as to defeat the purpose of a pilot trial, since there would be no potential for scaling up within or through the institution.
Second, choose one of two possible options for partnership development:
- State-owned banks as retailer rural finance institutions. In this case, assess whether the essential conditions for launching a pilot rural finance programme are met. The prerequisites here are, first, to get confirmation of senior management's full support to a pilot programme based on sound practices; second, to ensure its autonomy within the bank's operations; and, finally, to assess senior management's interest in scaling up the initiative, if shown to be successful.
- State-owned bank acts as a wholesaler (refinancing institution towards local RFIs). There are contexts in which a state-owned bank may have a stronger comparative advantage for assuming a refinancing role vis-à-vis local rural finance networks, rather than being a retailer in competition with them. This role is relevant when the lack of access to loan capital for local RFIs has been a significant constraint on their capacity to expand.
2.1.1 Assess the state-owned bank's financial situation and performance
The following indicators should be examined to evaluate the bank's financial position and their capacity to reach IFAD's target group:
- Sustainability – profitability, loan repayment rate, portfolio at risk, dependence on subsidies, etc.
- Outreach – penetration and quality of services delivered to the target market, volume of activity in target areas.
- Personnel and physical infrastructure – staffing, experience and involvement in rural areas.
- Liquidity – the capacity of the bank's funding base to service IFAD's target group.
- Management calibre – whether the bank is managed by well-qualified, professional staff, and especially that cadre who would be responsible for the IFAD client base.
- Reporting systems – the ability of the bank's management information system (MIS) to track and report on the performance of the institution and the loan portfolio.
- Management independence – whether and to what extent the bank is subject to political interference.
2.1.2 Assess the conditions that influence state-owned bank activities and that may be conducive to improving their operations
- Are macroeconomic and sectoral policies favourable? Does structural adjustment with macroeconomic financial liberalization favour change? Is the agricultural sector healthy and dynamic?
- Is there a strong coalition in favour of bank restructuring?
- Is there an effective framework for prudential regulation, legal recourse to enforce financial contracts, and efficient supervision?
2.1.3 Assess alternative rural finance options
- What is the current role assigned to the state-owned banks?
- Are state-owned banks likely to be closed within a few years, and which institution(s) might take over in the case of closure?
- What are the alternative mechanisms that IFAD clients use to access financial services? Can these be developed?
- What are the main hindrances discouraging other financial institutions (including financial cooperatives) from expanding into rural areas?
2.2 IFAD'S potential work with state-owned banks
Once the above general review has been carried out, IFAD has two main options: assess the possibility of developing a retail capacity within a state-owned bank (through a pilot rural finance programme), or consider the wholesale function. The following analysis underlines optimum conditions to start a pilot retail programme with a state-owned bank. What are not reflected, however, are some specific constraints in certain countries or contexts in which IFAD intervenes, and where a more incremental approach may need to be adopted.
2.2.1 The state-owned bank as retailer
This section draws heavily on the general guidelines in the Consultative Group to Assist the Poorest working paper "Should Your Commercial Bank Do Microcredit"?
18.104.22.168 Political commitment
An essential condition for pilot testing a microfinance programme with a state-owned bank will be that the chief executive officer and senior management, as well as executive board members, where relevant, are deeply committed to the process of exploring microfinance. Their commitment can be judged through discussions in the programme identification and formulation process, assessing their readiness to modify the bank structure were the pilot trial to be implemented. One issue that should be checked is the tenure of top management and board members, as many senior positions in state-owned banks are often filled by civil servants, whose tenures may be short. Short tenures militate against longer-term planning, weakening the ability to secure the right support.
The degree of commitment may also be measured by the resources the state-owned bank will contribute to fund the pilot experience, including readiness to assign promising young managers to take charge of the pilot programme, and to delegate an adequate number of qualified staff for programme implementation. Typically, in a microfinance pilot programme, at least six capable managers are needed, namely a general manager, plus managers covering operations; MIS; human resources; credit; product development; and marketing management.
22.214.171.124 Critical prerequisites for a pilot microfinance experiment
The strong political support from top management should be reflected in the agreement to secure minimum, essential conditions for the pilot operations (these have been essential factors in successful pilot experiences with state-owned banks). Requirements include:
- interest rates that permit full cost recovery. Spreads range typically from between 15 and 24% of average loan portfolios;
- effective collection efforts based on an efficient MIS (typically with a target of annual loan loss rates of less than 4% of the average annual portfolio;
- enforced accountability for all staff through performance-based incentive schemes;
- concrete mechanisms to reduce administrative costs and enhance loan recovery;
- substitution of traditional collateral-based lending by incremental credit relationships as the basis for microlending;
- elimination of programme-based loans in favour of cash flow and character-based assessments;
- rapid loan approval and disbursement processes to stimulate incentives for timely repayment in order to get repeat loans; and
- broad-based client groups across sectors to diffuse portfolio risk.
126.96.36.199 The need for autonomy and direct accountability within the structure of the state-owned bank
Microfinance operations have their own dynamics. They need to be able to process vast amounts of information quickly, to decentralize virtually all operational decisions, and to have a different type of loan officer and a more friendly client interface and accountability. These characteristics distinguish microcredit from most other banking operations. This implies that microfinance must be able to operate with a high degree of autonomy within the structure of a state-owned bank, and be administered separately from other banking services. Although microfinance services may be extended through the existing retail network of state-owned banks, they would most probably require separation in terms of staff, MIS, operating policies and organizational structure.
Above all, a successful microfinance operation will require that staff be held directly and immediately accountable for their individual performance (loan repayment, growth in client and loan volume, profitability of branch-level operations, and generation of savings in those cases where this is appropriate). Suitable accountability mechanisms will include paid incentives, connected to base pay; indirect incentives, such as staff travel and training; promotion; and, ultimately, the ability to sanction non-performers.
188.8.131.52 Various scenarios for the internal organization of microfinance operations
A microfinance pilot experiment can be organized in different ways – as a division within the bank, as a product line with its own staffing, as a loan processing subsidiary, or as an entirely separate entity. Whatever the structure adopted, however, the state-owned bank's MIS system must be able to track and report on the activities and results of the microfinance unit separately from other bank activities.
184.108.40.206 The need to set high performance standards
The microfinance pilot programme, if it is to succeed, will need to set high standards in terms of loan portfolio quality and profitability. This means that the programme must aim at full cost recovery, implying charging interest rates that are typically higher than the rates of any of the bank's other loan products. An important issue in this context is whether or not the government and the bank's political supervisors will allow such policies, once the programme becomes publicized. The danger is that the programme could be disrupted because of political pressure.
220.127.116.11 Time frame for the pilot experiment before considering scaling up within the institution
Most successful MFIs have learned the elements that are critical to their success through trial and error. State-owned banks should follow a process of experimentation, adjustment and repeated trials before launching microfinance services system-wide. This means that the bank should allow the microfinance programme at least two, if not three, years of operation for design, testing, adjusting and re-testing, before considering large-scale implementation.
Finally, the successful introduction of microfinance technology and capacity within a state-owned bank may have a major impact in terms of increasing access to financial services for poor people in rural areas. Bank Rakyat Indonesia changed from an inefficient state-owned bank in 1983-84 to a national network of village units that services millions of clients in rural areas. Other programmes, including the Bank for Agriculture and Agricultural Cooperatives in Thailand, and, more recently, Banco do Nordeste in Brazil, are also displaying very strong potential.
However, experience shows that only a very small minority of state-owned banks may be ready to experiment with microfinance and rural finance on basis discussed above. Establishing a priori very clear and strict criteria, based on the above considerations, should be seen as a prerequisite by IFAD before considering any such programme. Otherwise, there is a real danger that IFAD could duplicate past flaws in its programmes with state-owned banks, and repeat past mistakes.
2.2.2 The state-owned bank acts as a financial intermediary
In other contexts, IFAD might consider working with state-owned banks on a wholesale basis alone, and avoid involving them as financial retailers. This could be a valid approach when:
- difficulty in establishing access to loan capital from a commercial bank is an important constraint on local MFIs expanding their activities. The Caisses villageoises d'épargne et de crédit autogérées (CVECAs) (self-managed village banks) in Mali have successfully used refinancing from the Banque nationale agricultural de développement agricole in that context;
- state-owned banks have few branches outside the capital city and are not equipped to provide retail lending to microfinance clients (e.g. Western Africa);
- state-owned banks do not meet the criteria and conditions for launching a successful microfinance pilot experiment (as discussed in the previous section); or
- state-owned banks show little interest in retailing activities, nor do they have a comparative advantage to do so.
As financial intermediaries, state-owned banks would lend funds to local MFIs operating in rural areas. The scope for a financial partnership will depend on how much trust there is between the two types of institutions, the financial performance obtained, and the availability of resources on both sides. A lasting lending relationship usually depends on good management and financial results, and on transparent financial data reporting that the local MFIs can demonstrate to the lending bank.
However, caution should be used in reviewing this refinancing need, and the following factors should be taken into account:
- the impact of external resources in the MFI savings mobilization strategy (when it can mobilize savings);
- the MFI's actual need for external capital versus capacity building;
- the absorption capacity of the MFI for external capital and its ability to maintain high portfolio quality over time; and
- the options for long-term funding of the MFI portfolio.
Specific issues will need to be taken into account when considering such refinancing. For example, the pricing of loan capital should be higher than the cost for the MFI to mobilize savings (interest rate plus related administrative costs). Also, a major increase in the MFI loan portfolio (as a consequence of external funding) may tip the MFI's governance in favour of borrowers against savers: the potential consequence of this evolution will also need to be carefully monitored. Many savings-based institutions have been badly damaged, and sometimes destroyed in their structure and operations, by the massive injection of external capital from donors.
IFAD's potential role within such an approach could be to strengthen the understanding and trust between the two institutions. This can be achieved by providing technical assistance and training, preparing market surveys, assisting in the preparation of business plans, and providing some limited resources – seed money as a loan or small grant – at the initiation of the partnership.
2.3 Internet Resources for Further Reading
- Inter-American Development Bank (IADB)
- Microfinance Gateway
- The Ohio State University (OSU) Rural Finance Program
3. The role of participation in rural finance operations
3.1 Participation modes
Participation, in the present context, usually refers to client involvement in the operation of RFIs at various levels of intensity and complexity, according to the type of model under consideration, and so client participation usually falls into one of four forms.
- Participation in the design of products and services. This involvement can be classified as market research and involves clients in the identification and design of products that are suited to the client's needs. Such participation should be implemented in all microfinance system models. The relevant tools and supports are client satisfaction surveys, dropout surveys, and studies of households' seasonal incomes and expenditures, which together make it possible to target needs and their frequencies. The application of such tools is discussed later, in Section 8, with a description of the Atlantic Institute for Market Studies (AIMS) tools, MicroSave tools, and Market Research Toolkit. These could then be followed up with pilot testing of new products with selected clients, to judge the appropriateness of the products under local operating conditions.
- Participation in some of the operational aspects of service delivery. To maximize the programme's outreach, while minimizing operating costs, various duties and responsibilities can be outsourced to the clients themselves, and this concept is applied to varying degrees by the various approaches. Participation of this type is required where models use ‘solidarity group' methodologies, whereby groups have a role in screening members, an administrative role in filling out some documents, or even a role in initial savings collection and repayments for their group members. This participation reduces the workload for credit officers and lowers transaction costs for MFIs.
- Participation in the MFI decision-making process. This is typical of self-managed models, where client representatives cover most of the institutions' managerial tasks. This is the case in highly decentralized models, such as self-managed village banks (e.g. CVECAs) or financial services associations (FSAs), which are often active in disadvantaged areas where volunteer work is an effective way of making the system viable. Obvious tasks include credit decisions, expense authorization, and interest and dividend disbursements. In some cases, it may be difficult to get clients to take on these tasks, due to the cost in terms of time and additional risk involved. Hence, the willingness and interest of clients to undertake these duties should be explored at an early stage of formulation.
- Participation in MFI ownership and governance activities. Such participation is most common in client-owned MFIs, and membership-based MFIs (i.e. CUs, FSAs, CVECAs, village banks). The participation normally occurs as active involvement in executive board meetings, specialized committees and oversight functions, and annual general meetings.
3.2 Client participation: potential and limits
Client participation contributes to RFI sustainability by:
- helping ensure the pertinence of products and services;
- creating ownership in the system, with responsibility, loyalty and trust on the part of clients;
- contributing to reduction in overheads, through volunteer work and proximity information;
- providing a capital base through equity as shares and savings; and
- mobilizing support for the MFI's objectives.
While client participation and support to the RFI is crucial to its ultimate success, there are certain drawbacks inherent in such participation, which can negatively affect both the RFI itself and the clients themselves. These drawbacks include:
- Conflicts of interest. This can occur at all levels of the RFI and includes: collusion between elected members and agents for special loans to favoured individuals; increased per diem expenditures; reduction of loan interest rates by elected officers, most of whom are also borrowers; and non-collection of certain loans.
- Conflict over power and authority. This appears between elected members and technical staff in CUs, where staff ignore the interests of the membership as a whole.
- Borrower domination. Motivated by loan needs, borrowers may press for lower interest rates on loans, to the detriment of savers; or village elders might appropriate all the loans for themselves.
Hence, promotion of participation should be addressed within the larger context of good governance, in order to ensure appropriate supervision of RFI management and operations, and help preclude the development of negative aspects of participation.
3.3 Promoting Suitable Participation that Strengthens Rural Finance Institutional Sustainability
In IFAD's rural finance programmes, focus should be placed on promoting client participation, while taking into account client interest in, and ability to benefit from, such participation. One should keep in mind that sustainable access to financial services, both credit and savings, that are designed specifically to meet their needs is very often a primary objective for those clients, an objective that participation should help to achieve. That being said, the degree of participation will depend on the:
- level of self-promotion and solidarity in the RFI client base itself, that group's past experience in participatory activities, and their willingness to participate;
- poor people's level of literacy and education, vis-à-vis the undertaking of administrative and managerial tasks;
- availability of the people's representatives and their willingness to devote time to undertaking repetitive tasks on a voluntary basis; and
- MFI institutionalization schema: is it membership-based or client-based?
The type and scope of participation should always be adapted to each specific situation, to the capacity and will of local actors, and to the institutional setting of rural finance partners (CU, financial NGO, non-bank financial institution, etc.).
Regardless of the context and system chosen, client participation in defining products and financial services always seems to be both feasible and desirable as it ensures that supply closely matches demand, and that products will be adjusted to clients' potential and constraints.
Client participation in management should only be envisaged when it corresponds to an expressed desire (for example, request from a farmer organization) and is within the capabilities of the membership to provide. Moreover, it must have the specific aim of limiting the system's intermediation costs, therefore making it possible to extend outreach to very poor and remote areas.
Client participation in equity financing or debt mobilization undeniably increases the sense of ownership and responsibility vis-à-vis the system, and is to be encouraged where and when financially feasible. The debate remains open, however, with regard to the potential problems generated as a result of conflict of interest deriving from clients' dual roles – as both shareholders and service users – especially if the shareholder role allows them to influence the system's operational decisions (e.g. interest rates, conditions, modalities).
In designing and implementing microfinance programmes, IFAD should always endeavour to optimize the potential provided by the constructive and voluntary participation of beneficiaries. This should help ensure that needs of the target populations are met, while helping prevent the development of any flaw in the sustainability process that could be attributable to artificial and forced participation.
The link between participation and empowerment may be further investigated in the context of IFAD rural finance programmes. Empowerment of the poor may be achieved by their participation in operational responsibilities at the local level in certain contexts (very decentralized systems), although such participation might also be seen in other contexts as a constraint, with a high opportunity cost (time, absence of remuneration, etc.). Empowerment can also be strengthened by a sense of ownership in the RFI, thereby ensuring that the RFI is managed for their long-term benefit. This can happen not only with mutualist systems, but also with financial NGOs that have been transformed into licensed institutions. In these cases, part of the equity (from donors) could be transferred to clients, through an appropriate holding structure (such as those used by the Association of Cambodian Local Economic Development Agencies or by the Center for Agriculture and Rural Development in The Philippines).
Finally, the empowerment gained through access to appropriate financial services will be reflected in many aspects of local social organization, and through strengthened negotiation capacity vis-à-vis external actors. This aspect of empowerment may be assessed through impact studies, and the AIMS tool proposes a specific instrument for that purpose.
3.4 Internet Resources for Further Reading
- Consultative Group to Assist the Poorest (CGAP)
- International Fund for Agricultural Development (IFAD)
- Microfinance Gateway
Recent research has confirmed that savings are key financial services for the poor in general, and for the rural poor in particular. In this regard, both researchers and practitioners have specifically noted that:
- There is a strong demand by the poor themselves for safe, accessible and flexible savings services.
- The poor can save, and saving is a crucial factor in reducing their vulnerability and supporting their efforts to overcome poverty.
- Client feelings of ownership are stronger in those institutions that deal with savings mobilization, and this may have a significant effect on their behaviour in loan repayment.
- Institutions can diversify their resources through savings mobilization, thereby reducing their dependency on subsidies or donor funds.
- Local savings may be cheaper resources than commercial funds and can therefore help the institution to reach profitability at an earlier stage in its development. At the same time, the cost of managing savings is more expensive than managing a bank line of credit, and it carries a higher level of liquidity risk.
4.1 Preconditions for Savings Mobilization
Before embarking on savings mobilization, some preconditions should be met concerning the socio-economic environment. These include: overall security in the area; a low and steady inflation rate (to avoid the risk of negative real interest rates being offered on deposits); and a reasonable level of monetization in the economy, thereby permitting savings in monetary instruments.
Once the socio-economic preconditions are met, other preconditions need to be considered. These concern the MFI itself and its capacity to mobilize savings safely, including:
- Strong governance and professional management. These factors are even more important when an RFI mobilizes savings, since higher levels of technical skill are required (liquidity management) and the fiduciary responsibilities are greater.
- Strength and reliability, with solid internal control and financial systems. The provision of accurate, timely information is absolutely critical when RFIs mobilize savings. Managing deposits implies a higher volume of less predictable transactions. It also requires close and accurate monitoring of individual accounts – a key to maintaining client trust.
- Ensuring that the MFI never uses deposits and savings to cover operating expenses. So for an MFI that mobilizes savings while not having reached operational self-sufficiency, such as a recently established CU, it is imperative to ascertain the availability of grant funding from donor sources to cover the excess of operating expenses over income.
- A history of strong loan portfolio quality management. As savings will be used in large part to fund the loan portfolio, it is extremely important that loan portfolio losses are minimal.
Finally, the need for effective supervision from regulatory authorities needs to be assessed.
- In countries where a legal and regulatory framework for microfinance exists, an MFI might have to be licensed and supervised by a central bank before it is allowed to mobilize savings (except for small and very decentralized systems that only mobilize members' deposits).
- Although supervision is necessary for ensuring the security of deposits, central banks frequently lack the capacity and the instruments for effective supervision. In addition, some MFIs may have difficulty in bearing the cost of meeting the information requirements related to supervision. In this context, the challenge is to help the government develop a combination of strategies that can best protect depositors, while adapting to the specific constraints of microfinance. One principle should be that while the reporting requirements of the MFI may vary according to activity, size, legal structure, etc., the level of accountability must be consistent across the entire sector.
- Unless the above conditions are met, it is recommended that MFIs should be discouraged from mobilizing local savings from their clients or from the public.
4.2 Design of Demand-Driven Savings Products
Traditionally, group lending methodology implies some form of compulsory savings from the client, while the individual lending methodology requires compulsory savings less frequently. Compulsory savings, when required, are contributed either prior to loan disbursement or subtracted from the loan capital, or as sums deposited on a regular basis after disbursement. Often, 10% of the loan amount is required as mandatory savings and is supposed to guarantee loan repayment.
Questions are now being raised about whether, in the long run, compulsory savings serve either the client or the MFI. The compulsory savings approach to savings is not conducive to encouraging a savings habit among clients. They simply consider it as one of the requirements for accessing loans, and not part of their own saving strategy. As they rarely contribute more than the minimum amount required, savings mobilization usually does not progress over time, and such savings are frequently withdrawn at the earliest possible opportunity. Paradoxically, the same clients often continue to save outside the system, either in rotational savings and credit associations (ROSCAs) or in kind, yet saving in kind can be very risky.
Experience has shown that it is the mobilization of voluntary savings that can have the strongest impact on the lives of poor people. It is also the best approach for providing the MFI with a significant amount of funds to diversify its resources, and contribute to financial sustainability.
To mobilize voluntary savings, however, the MFI has to design products that fit client demands. In order to design attractive savings products, the MFI will need to:
- verify that there is a savings mentality within the local culture;
- ascertain whether potential clients trust the local currency and are prepared to use it as an instrument for savings;
- get a clear understanding of household budgets and cash flow patterns, especially for rural households with important seasonal variations;
- develop an in-depth knowledge of household economic and risk management strategies and coping mechanisms;
- analyse the existing formal and informal savings mechanisms, with their ease of access, advantages and constraints; and
- involve the clients in the design of a product that can meet their needs.
Typically, a savings product designed to meet client satisfaction will reflect:
- safety, which involves physical protection (a solid safe in a guarded building) and sound procedures and management skills;
- flexibility, which means open-ended possibilities to choose the amount and the duration of saving patterns, and, for the more flexible products, clients should be able to withdraw money rapidly and at any time; and
- accessibility, reflecting availability of funds close at hand, thus avoiding time and transport costs for depositing or withdrawing.
Poor clients are usually not very sensitive to interest rate incentives, especially in places where alternative savings services are not available to this segment of clientele. Some informal savings systems actually charge clients for the services they offer, since clients value security over earnings.
Nevertheless, there may be some trade-offs between safety, flexibility and accessibility when operating in a very decentralized situation, especially when there are no banks nearby in which MFIs can deposit their extra liquidity. In these cases, the MFI may choose to offer a less flexible product (term-deposit, for instance), which is easier to manage and may be partially transformed into loans locally, in order to avoid a surplus of cash in local safes at certain periods of the year (e.g. harvest time).
4.3 Implication of Savings Mobilization: Recommendations for IFAD
Supporting RFIs to mobilize deposits carries high risks and is a serious matter. The donor doing so assumes at least a moral responsibility of assuring the poor that their savings are secure. This gives IFAD a moral obligation to verify that the RFIs it supports have the necessary managerial and technical skills to operate effectively, and also to meet the criteria mentioned earlier, such as in Section 4.1. Hence, RFIs need to be carefully selected and assessed before entering into partnership with them.
Few donors are equipped to support savings mobilization initiatives. In comparison with supporting credit programmes alone, savings mobilization requires closer and more intensive monitoring, together with understanding of a set of entirely different dynamics. Consequently, donors involved in supporting savings mobilization should have both the structure and the capacity to:
- identify and mobilize the appropriate technical expertise in support of MFI partners, and closely monitor their progress;
- undertake a long-term commitment involving significant risk, and some funding, mostly directed towards technical assistance;
- ensure that the MFIs understand and abide by any legal and regulatory requirements; and
- confirm that the MFI has an appropriate MIS system to effectively manage savings.
Regarding possible entry points for supporting savings mobilization, IFAD's involvement might imply active intervention in several areas.
- Coordination of donor discussions with governments and central banks in relation to the policies, laws and regulations needed to facilitate mobilization of small deposits and to protect small-scale savers. For example, interest rate deregulation could have a critical impact in enabling MFIs to offer appropriate interest yields on deposits, or at least to protect them against the erosion of inflation. Creation of such an enabling environment is best undertaken in conjunction with other multilateral institutions, such as the World Bank.
- Use of grants for capacity building of regulatory and supervisory bodies, for research into and development of savings products and market study tools, and for information dissemination of best practices in deposit mobilization and institutional development for retail institutions wishing to create liquidity pools.
- Awareness-raising of limits and potentials, so that when funding a savings mobilization institution, a very useful contribution on the part of IFAD will be to help this institution to understand more fully the costs and risks of mobilizing savings, and to determine appropriate pricing for deposit services. Costing and pricing of savings services remains a major challenge for many RFIs. The testing of costing and pricing modules, such as the one developed by MicroSave, has proved to be of vital importance for some MFIs (and even for more formal institutions, such as postal savings banks), helping them to assess the profitability and viability of those services within their own institutional context.
- Support to pilot experiments to increase the outreach for savings services. Providing voluntary deposit services to remote and very poor clients has remained a major challenge in rural finance. Very few institutions have been able to do so on a sustainable basis. IFAD could provide a valuable contribution in helping to extend the frontier of rural finance in that direction, through funding promising pilot programmes and initiatives. The recently approved Pro-Poor Rural Finance Innovation Fund set up by IFAD and CGAP may offer an appropriate instrument for supporting such initiatives.
For further development of the general theme of this section, see Developing Deposit Services for thePoor: Preliminary Guidance for the Donors, by the savings working group of CGAP.
In some disadvantaged areas, emigration remittances are a major source of income for households. There are both seasonal emigration patterns, to nearby regions and towns, and the more long-term emigration to foreign countries. Transfer back home of money from long-term emigrants is a very valuable financial service and it can add up, in many cases, to a large volume and number of transactions.
In countries where banks are present in all major towns, transfers can be made effectively, even if at a high cost. In countries where banks are concentrated in the capital cities and postal banks are not operational, there are no such services to meet the needs of emigrants, who want to send their money back home while avoiding excessive transfer costs to families.
For those MFIs operating in remote rural areas, this represents a very meaningful and lucrative market if they can establish an attractive transfer service for emigrants. It represents a way to attract new rural clients, and will encourage the development of new savings products for this category of wage earners and their families. Additionally, it will boost and diversify the sources of revenue for the institution through service charges while contributing to the economic development of poor rural areas by converting local-external resources into productive investment in the local economy.
Providing appropriate solutions for this demand is definitely a major challenge for RFIs operating in poor regions everywhere. However, with a creative approach – possibly including partnerships with banks in the various countries, local transfer mechanisms, and specially designed long-term savings products – the remittances from emigrants can have a substantial impact on the underlying performance of the RFIs and their clients.
While the benefits to both the RFI and the client base can be substantial, the risks and requirements associated with handling this service must be very carefully assessed before an RFI enters this market, addressing legal status, security and transport of funds, management and staff capacity, internal control, MIS, etc.
4.5 Internet Resources for Further Reading
This section draws largely on a 1999 study commissioned by the United Nations Capital Development Programme from the International Centre for Development and Research (CIDR) on How to push the frontiers of microfinance into remote rural areas.
It is very difficult to generalize with regard to the conditions necessary for sustainability in remote rural areas because microfinance promoters maximize their chances of success on a case-by-case basis. They do this by judiciously combining the various local factors that have been identified for reducing costs and increasing revenues, while maintaining reliable, high-quality operating systems. So as to minimize the recurrent costs associated with the constraints faced in remote areas, innovations are crucial in order for RFIs to achieve sustainability.
Based on experience, a number of practical recommendations can be drawn up regarding (i) minimum conditions required for a successful rural finance intervention, as evaluated in prefeasibility studies; (ii) adaptability of services, defined in feasibility studies; and (iii) innovations to be promoted with action-research programmes.
5.1 How Can IFAD Assess the Minimum Conditions Required to Justify Rural Finance Interventions? What Are the Main Constraints Facing Rural Finance in Remote Rural Areas?
5.1.1 General prerequisites for microfinance
There are some general prerequisites for implementing microfinance programmes in any given country. These include basic political and macroeconomic stability (absence of very high inflation); basic security (enabling relatively safe transportation and use of funds); a minimum degree of monetization of the local economy; and a minimum population density to support a viable RFI.
The feasibility of any rural finance intervention should be carefully assessed in the light of the presence or absence of the above preconditions. In that context, the decision to fund a rural finance intervention should be based on a clear prospect for the rural finance partner to be able to reach – within the agreed time frame – the twin objectives of outreach and sustainability.
5.1.2 The main constraints for microfinance in remote and disadvantaged areas
There are typically four main constraints.
- Low population density. Gathering a critical mass of clients inevitably means reaching many villages and thus relying on a tenuous network. Experience has shown that the minimum population density to ensure potential sustainability for a rural finance structure should be around 10 to 15 inhabitants per square kilometre. The total operational area would need to cover at least 200 villages with about 300 000 total inhabitants. The question that must therefore be asked at the formulation stage is: Are sufficient clients reachable at reasonable transaction costs?
- Low level and precariousness of monetary income. Diversifying risks (agricultural risks, saturation of local markets, etc.) necessitates identifying, with the clients, a large range of activities, and especially activities that can be conducted independently of climate variations. The questions to be asked could be: What are the main activities? Are they all related to agriculture? What are the main risks?
- Non-existent, inadequate or defective infrastructure. Where roads, electricity supply, telephone services, education systems, etc., are suboptimal, transaction costs (for transport, in particular) are higher, and rural finance programmes will face extra costs to compensate for those deficiencies. One must then ask: What will it cost to compensate for the low level of infrastructure?
- Difficulty in hiring and retaining skilled, professional staff. Rural populations suffer from higher levels of illiteracy than do urban populations, thus complicating the recruitment of trained staff. Furthermore, trained, urban-based staff are often reluctant to move to rural areas. The question is then: How can RFIs attract and retain professional management?
5.1.3 Analysis of geographical and economic conditions
Microfinance clearly is not the solution to problems in areas where monetary transactions are scarce and where access to capital is not an appropriate response to people's most urgent needs. Three types of surveys should help provide a better understanding of the issues involved:
- Analysis of household budgets. What are the main sources of income? What is the share of monthly income and expenditure compared to the share of barter and personal consumption requirements? What are households' money requirements and what are the levels of disposable income? When, how often and how does money circulate within households?
- The current supply of credit. What are people's experience with monetary transactions? From where do the potential clients currently obtain credit when it is needed?
- Analysis of local markets. How many local markets are there in the area? How frequently do these markets take place? How many people travel to them? How much money circulates there? What goods are traded? Where does the merchandise come from?
5.1.4 Social and cultural conditions
In poor and isolated areas, social mobilization and well-respected cultural values can be drawn upon to minimize costs and accelerate implementation. It is essential, therefore, to accurately identify the social and cultural assets of an area at the outset, implying:
- analysis of the presence of traditional informal organizations, or of organizations that have grown out of successful development programmes, indicative of social cohesion, and of the population's readiness to mobilize so as to overcome hostile external conditions;
- analysis of collaborative practices, experience in resource management, and the rules that have been established over time; and
- analysis of the strength of cultural values such as honour, solidarity, integrity and service to others, where strong positive cultural values can limit the costs associated with fraud, misappropriation, deliberate delinquency.
In order to assess these cultural assets, in-depth studies need to be conducted at village and group levels.
- At the village level, consider the history of the village and of village initiatives. What kinds of problems have these initiatives been able to solve? How does the village organize itself? How are important decisions made in the village?
- At groups and informal organization level, assess the origin of their establishment, their achievements, funds accumulated, form of management, experience with credit, and future prospects.
5.2 How Can Rural Finance Institutions Adapt their Operations to Reach their Target Client Groups in Remote Rural Areas?
In remote areas, not all approaches necessarily produce convincing and sustainable results. Various components influence the success or otherwise of a rural finance programme, and therefore need to be decided upon on an individual basis.
It is strongly recommended that, at some stage, future and potential clients become involved in selecting the methodology to be utilized, at least in order to be sure that it suits their needs and is capable of providing the clients with the appropriate services.
Experience has shown that, in these types of remote contexts, MFIs need to:
- identify mechanisms for decentralizing a considerable portion of decision-making responsibilities, and transferring various management tasks to the clients and their organizations. A centralized structure would be too expensive and could not be controlled over the distances involved;
- see themselves as autonomous regional enterprises. Establishing mechanisms for adjustment from one region to another is not easy. While it is possible to mobilize a great deal of effort to sustain a regional structure, such effort is weakened by dilution on the national scale; and
- seek contractual relationships with national financial institutions (banks or mutualist networks) to meet refinancing needs in order to supplement local resources. This will help provide access to commercial resources from outside the area on a sustainable basis. In order to encourage relations between banks and eliminate any mutual distrust, it is important to improve MIS, publish audited financial reports, and classify the MFIs according to predetermined criteria, using a rating system.
5.2.2 Selecting the right rural finance institution operator, and designing an appropriate partnership
The success of overall rural finance operations calls for a certain level of skills and experience, so that the MFI can manage its affairs and produce innovative ideas with a high degree of confidence. It is better to abandon an attempt to create or support a RFI than to launch one in a difficult area with an unqualified partner or operator.
Clearly, the rural finance partner should not be chosen solely on the grounds of prior presence in the area, but rather on the basis of convincing results that demonstrate its ability to conduct microfinance activities professionally under such conditions. In the absence of a professional rural finance operator in the area, IFAD will have to find incentives to induce the chosen operator to consider extending activities to the area in question.
IFAD should consider assigning the task of conducting the feasibility study to the rural finance partner, so as to build commitment to the programme. This study will serve both to compile information for relevant decision-making, and to establish the contractual basis for partnership. After an appropriate level of review, the study could form the basis of a long-term commitment from both sides.
The establishment of mutually agreed performance and activity indicators will provide the basis for evaluating progress towards the sustainability objectives.
5.2.3 Resources to be made available
In remote and vulnerable regions, the progress of rural finance programmes from start-up to full sustainability can take ten years or more. In certain circumstances, where positive factors compensate for other shortcomings, this process may take eight years. The need to spread support over two programme phases should be anticipated, with care taken to ensure that there is no interruption between phases. The expected duration should be incorporated in a ‘generic contract' even if administrative procedures do not allow donors to commit financially beyond a certain statutory period.
Investing in remote areas also requires larger financial outlays. Additional training needs to be provided, while more time is needed for developing tools and approaches suited to the environment. Moreover, the equipment and hardware need to be sturdier in order to withstand the more challenging climatic and environmental conditions.
A posteriori calculations by CIDR show that the cost of establishing a rural finance network in a remote area is likely to be about 80% higher than establishing such a network in more accessible regions. Donors can play a major role in supporting the establishment of such RFIs by setting up appropriate financial tools to provide longer-term support, such as the "funds for securing loans that can be transformed into capitalization funds" approach developed by Appui au développement autonome – a Luxembourg-based NGO with the Réseau des caisses populaires de Burkina Faso network, and described by Adams (1998) in La garantie bancaire dans le contexte des caisses populaires et des caisses villageoises au Burkina-Faso.
5.2.4 Services to reach target groups in remote rural areas
Diversifying services and financial products helps RFIs to spread their risk while serving a broader range of clients in the target group. Diversification can be obtained by some combination of:
- expanding the range of products and services suitable for household needs (credit and savings), and helping households to better manage their own risks and vulnerability;
- broadening the clientele (to include men, women, youths, and groups such as local associations, etc.); and
- establishing simultaneous operations in more favourable regions so as to compensate for the risks of the remoter areas.
Such diversification, however, necessitates changes in operating procedures and, often, improvement in the agents' ability to analyse risk. Hence, any diversification strategy must be supported by appropriate staff training.
An important step in this process is pilot testing of financial services before rolling them out on a larger scale. This should help ensure that they are well suited to the requirements of the RFI client base, as well as to the RFI itself.
Savings are likely to be particularly important in rural areas and so the associated demand for savings-related services should be carefully assessed, as discussed later, in Section 12.
5.3 Innovations Rural Finance Institutions Might Consider for Interventions in Remote Rural Areas to be Sustainable
The are three major areas of innovation that can be explored by RFIs seeking to reach sustainability in remote rural areas, namely outreach mechanisms, management, and governance. These are briefly analysed below.
5.3.1 Outreach mechanisms
- How can rural finance institutions secure loans with new forms of guarantees? The diminishing reliability of joint liability (due to conflicts between group members, pressure from influential borrowers, social differentiation, fictitious groups, and competition from other MFIs removing the threat of exclusion from access to credit) may call for a closer look at other forms of guarantee.
- How can RFIs extend outreach with new contractual relationships? Relationships between RFIs and their clients may be handled at village level, using, for example "village contracts". Under this approach, the credit agent who generally deals with individual clients may manage a village contract as the sole legal entity, using simplified monitoring procedures, while the individual members manage the internal affairs of the group. This enables the credit agent to multiply their loan portfolio considerably. This approach has been successfully applied for the activities of Rural Credit of Guinea.
- How can RFIs control costs? Normally, labour and transportation costs represent more than 60% of the total administrative costs of RFIs, and the need to control them is clear. Innovative approaches should be used to facilitate a high degree of client involvement and division of labour between borrowers' representatives and paid technicians, in line with their respective areas of competence.
- How can RFIs increase revenues? Interest rate constraints may remain strong (due to competition from charitable organizations not concerned with sustainability, or limited profitability of investment opportunities for clients), so innovation should focus on increasing the volume of loans, through progressively larger loan amounts per loan cycle, and through diversifying services and clients.
- How can RFIs improve their agents' productivity? RFIs should focus on simplifying procedures and on staff training. Close monitoring of and acquaintance with the clients is important in this regard.
- How can RFIs draw on a society's social cohesion to compensate for the area's economic handicaps? Some of the existing customs and structures that can be used in this regard include traditional groups used to working together and practising joint management; solidarity and social cohesion resulting from years of collective struggle against a hostile environment; the authority of the elders; and village-related decisions taken collectively in a village assembly.
- How can RFIs implement systems of checks and balances, mobilize social pressure and introduce incentive mechanisms? The profit sharing mechanism used in CVECAs is an interesting example.
- How can RFIs foster high levels of participation and a strong sense of ownership? These are prerequisites for ensuring success and reducing costs. Moreover, certain tasks that do not require travel are better performed by villagers than by paid staff (loan applications, for example). Participation and a sense of ownership (or identification) on the part of clients are also essential elements in building loyalty.
5.4 Internet Resources for Further Reading
- International Fund for Agricultural Development (IFAD)
- Special Unit for Microfinance (United Nations Development Programme (UNDP)/United Nations Capital Development Fund (UNCDF))
- Sustainable Banking with the Poor (World Bank) (publications; Rural and micro finance/SME)
6. Balancing the pros and cons: providing loan capital versus funding capacity building and technical assistance
For a considerable period, IFAD's lines of credit for the rural poor focused on financing agricultural production and purchasing capital equipment. These lines of credit were channelled through banks or through integrated rural development projects. The repayment rates and social impact of those instruments have been very mixed, causing the Fund to revise its approach. Today, IFAD places more emphasis on strengthening the capacities of autonomous MFIs in rural areas and, hence, faces the challenge of adjusting its financial tools accordingly. This change of tack begs the question of what are the needs at each stage of the MFI's development cycle regarding institutional strengthening and loan capital, and what portions of programme budgets might be envisaged for each type of support.
The appropriate balance between, on the one hand, institutional strengthening and technical assistance and, on the other, loan capital, should also be defined in the context of building strong partnerships with RFIs, whereby IFAD's support mix would be provided based on the RFIs' own development plans, and would reflect their commitment to meet mutually agreed minimum performance benchmarks. IFAD support should also reflect, whenever possible, close donor partnerships, where each party would seek to maximize the impact of their respective intervention, such as the ability of bilateral donors to provide grant funding to support rural finance institutional strengthening.
6.1 Microfinance institution needs according to maturity
The general phases of development for most MFIs are start up; growth; and maturity and institutionalization. The needs of MFIs vary, though, at each stage and according to their level of maturity and development. These phases and the types of assistance required are discussed below.
6.1.1 Start-up phase
During their early years, MFIs need grants, above all, so as to be able to build their capacities, develop their organizations, perfect their products and services, and install the tools and functions required for efficient operation. Even if they mobilize client savings, they usually also need capital – in the form of grant funds or loans at low rates – to strengthen their loan resources. At this stage, however, specialized technical assistance is the decisive factor in providing young structures with the basic knowledge they need for sustainable growth.
6.1.2 Growth phase
During the growth period, MFIs extend their outreach, widen their geographical coverage, and increase their transaction volumes. Grants become crucial for developing and equipping new branch offices, training new agents, and acquiring the appropriate MIS technology. Since the MFI is not able to cover its full operating costs through the income generated by its portfolio, subsidies to cover these costs are still very much justified.
Loan capital requirements are considerable during this stage, and may be fulfilled in different ways. Some MFIs may fund most of their growth by mobilizing savings (e.g. CUs), or may need to combine internal and external resources. In this case, access to external capital should be facilitated while taking into account (i) its impact on the MFI's strategy to mobilize savings, (ii) its cost and impact on MFI profitability, and (iii) the long-term funding of the MFI loan portfolio.
Point (iii) raises the following issue: If loan capital is provided from donor funding (or from a subsidiary loan agreement between the government and the MFI, in the case of IFAD), then the availability of such funding in the long term needs to be assessed. The repayment schedule of the subsidiary loan from the MFI to the government must be harmonized with the mobilization of alternative resources (through equity, savings or other sources) in order to avoid disruption in the funding of the loan portfolio. A powerful incentive would be to transform a government subsidiary loan into equity, based on the MFI's ability to meet minimum performance standards, such as in terms of client outreach, portfolio quality and operational self sufficiency. This equity would be subscribed in the name of local stakeholders (clients, or MFI staff, for example), as a way to strengthen local ownership, and should obviously not be used to increase government equity participation in the MFI.
During this growth phase, some MFIs may become sufficiently strong to start accessing loan capital from banks on a commercial basis. This scenario may require support from donors (or specialized entities) in the form of guarantees, to facilitate refinancing relationships between commercial banks and the MFIs. However, this approach needs to be considered with caution, since overall donor experience with guarantee funds has been rather negative, as it can encourage moral hazard on the part of the lending banks.
6.1.3 Maturity and institutionalization phase
At the institutionalization stage, the MFI has achieved the necessary economies of scale for long-term sustainability, and has developed a successful business model. At this stage, institution-building support is a fundamental intellectual input to guide its choices, upgrade procedures, adopt the most appropriate legal vehicle, review its overall internal organization, and to prepare for transformation.
This transformation may require strengthening the MFI equity base by bringing in new shareholders or investors, who also could provide additional technical expertise. At this stage, dependence on donor loan capital should end, since the newly matured MFI has the possibility of raising financial resources in the local financial markets (debt or equity), or through deposit mobilization.
Overall, keeping the right balance between funding capacity building and the provision of loan capital is a great challenge, especially for IFAD, whose principal funding instrument has been long-term lending to governments. The ideal option would be to maintain a certain flexibility in supporting an MFI, without strict earmarking of funds towards capacity building and loan capital, but rather to identify several minimum performance criteria that will condition continuation of support from IFAD to this MFI.
The inclination for governments to use IFAD resources for extending loans to MFIs for on-lending (as opposed to providing technical assistance) is real and may be understandable. However, this approach should be challenged, by emphasizing the following arguments:
- The primary need and challenge for MFIs in developing countries remains access to grant funding for capacity building and institutional strengthening. Sources of loan capital are usually less scarce, and can be accessed from governments, or from large donor programmes. It is moreover possible to build in as much "discipline" and conditionality for accessing grant funding as it is for providing loan capital (e.g. through minimum performance standards).
- Efficient use of grant funding for capacity building can help an MFI reach sustainability and convert to a licensed institution. With such a licence, this MFI may be able to leverage up to twelve times its equity in the local financial markets (or through savings mobilization). This tremendous leverage of initial donor grant funding should be brought to the attention of governments.
When a lending facility in favour of MFIs is set up within an IFAD programme or project, clear and transparent criteria for accessing this facility should be agreed upon at appraisal. Access to loan funds should be conditioned on:
- avoiding a negative impact on the MFI's saving mobilization strategy (if applicable);
- the absorption capacity of the MFI and its ability to maintain high portfolio quality; and
- the MFI's long-term strategy for funding its loan portfolio, and its compatibility with using external resources.
6.2 What Does Capacity Building Include?
Capacity building and institutional strengthening can comprise several forms of support, covering human resources development, operations, methodologies and product development.
6.2.1 Human resources
- Designing staff hiring policies and procedures;
- planning staff training;
- elaborating training modules for staff; and
- supporting staff assessment and motivation.
- Organizing branch offices;
- organizing headquarters and headquarter divisions;
- preparing procedural manuals on administration, accounting, operations and internal control;
- managing information systems; and
- establishing internal control systems.
6.2.3 Methodologies and tools
- Developing techniques for mobilizing savings;
- reinforcing loan analysis and management;
- implementing marketing research and client surveys, evolving into marketing plans; and
- means of reaching out to rural areas and villages.
6.2.4 Product development
- Designing savings products;
- designing credit products; and
- designing new products, such as insurance and leasing.
Technical assistance may help adjust methodologies, tools and products, and provide training and support for loan agents and executives. Technical assistance could also include the supply of computer equipment and software (MIS systems), or support the launching of pilot operations in rural or poorly served areas.
6.3 Appropriate Technical Assistance and Skill Transfer Contracts
Each stage of MFI development necessitates a differentiated approach to capacity building, but such support and advice should not be provided by generalists, and even less so by local, non-specialized NGOs. Reliance on short, generalist visits with no continuity is likely to increase confusion about focus, accumulate incoherent tools, and retard progress towards growth and institutionalization. In that context, IFAD should make use of specialized and experienced technical assistance whose expertise is proven and acknowledged internationally.
Technical assistance may be provided either by a specialized consultant through short field visits, or by the long-term local presence of a technical adviser. The consultant or adviser might be hired by IFAD directly, or work for a specialized organization (consulting firm, specialized NGO), or they could be external contractual operators hired for the development of a new rural finance network. Finally, use could also be made of in-house advisors from an existing RFI or bank who can provide the additional skills needed for the development of the structure.
Faced with the challenge of helping to build new rural finance networks or strengthen local or nationwide RFIs, IFAD may need to recruit a national, regional or international rural finance partner (operator) to assume local responsibility. In this situation, it is important to set the right selection framework to attract the best expertise, and make the rural finance partner accountable for the results. Where tendering is used for such recruitment, the following framework of a request for proposals could be used – adapted as needed – for selecting potential applicants. Such a request for proposals needs to address both technical and financial dimensions.
The technical proposal submitted by applicants should include:
- A brief description of the rural finance operator, its microfinance projects or programmes (both under way and planned), and the administrative, financial and technical support services it can provide.
- An outline of the broad strategy proposed for the programme. This should include descriptions of the methodology and outreach mechanisms; type(s) of services envisioned; estimates of outreach (e.g. number of clients); and the time horizon for reaching sustainability. A description of the exit strategy should also be provided, including an indication of the local structure(s) that could take over after programme completion, with consideration of their legal status, governance, etc. Note that, at this stage, it will not be appropriate to request detailed feasibility studies and business plans, especially if there is competition between several potential partners. The aim is rather to select the more suitable rural finance partner(s) for the programme, based on a generic proposal, although with clear methodology and quantitative targets. The winner(s) would thereafter be asked to elaborate a detailed strategic plan that will typically reflect elements of the in-depth feasibility studies, as discussed earlier.
- Proposals for the use of programme funds (as per the budget), with a breakdown among loan capital, technical assistance, capacity building and operating costs.
- The human resources proposed for implementation of programme activities (Curricula vitae and references).
- A preliminary work plan or business plan, including a time line.
In order to rank the proposals for final selection, a scoring methodology might be used. On the basis of a scale of 100 points, each proposal could be evaluated as follows, although the number of points given in the example below are illustrative, and are intended to illustrate how the relative weight and importance of each section may be defined when reviewing a proposal:
- the microfinance operator's experience at successfully managing a sustainable RFI – 30 points;
- the proposed strategic and operational strategies proposed for implementation. These strategies should include descriptions of how operational and financial autonomy will be achieved, and the exit plan – 35 points; and
- the qualifications and skills required for the supervision and management team proposed for the project – 35 points. The actual competence and experience of the operating staff assigned to the project are key selection criteria. They are, in fact, the best assurance of the quality of the assistance to be provided.
In addition to the above-mentioned scoring approach, the financial effectiveness of the proposal should be evaluated. In order to introduce incentives for cost-effectiveness, proposals should also be ranked financially, but experience has shown that it is advisable to give more weight to the quality of the technical proposal presented, rather than simple cost. What should be carefully assessed in that context is the volume of total assets planned at programme conclusion (loan portfolio, number of staff trained, physical rural finance infrastructure set up) as well as the loan portfolio quality, the programme efficiency (portfolio per loan officer, etc.) and the range of services provided. These are compared to the cost of the proposal. The loan portfolio projections, however, need to be treated with strong caution, as requests for proposals may project results that are unrealistic given the known operating environment, in order to render the proposal more attractive. The financial proposal may account for 30% of final grading, while the technical proposal may count for 70%.
All applications from entities that do not have experience as microfinance operators or practitioners, or that have not developed specialized microfinance departments, should be excluded. In order to avoid prolonged technical assistance due to insufficient transfer of skills to local stakeholders, the transfer stages and indicators should be contractually binding and monitored.
6.4 How to Address Different Country Perceptions Regarding the Need to Fund Capacity Building
In some countries, governments clearly recognize a very strong need for MFI capacity building, and may be ready to allocate a large part of their rural finance programme budgets to fund both capacity building and technical assistance. In these cases, IFAD could launch its projects and programmes to interdigitate with and complement the local thrusts.
In other countries, however, governments may hesitate to allocate substantial resources to capacity building, especially when they fund their rural finance programmes through donor loans. In such cases, IFAD may want to condition the commitment of its resources to its ability to mobilize additional grant funds from other donors to cover the capacity building and technical assistance needs of recipient RFIs.
6.5 Internet Resources for Further Reading
- Appui au développement autonome (ADA) and Centre de recherche en microfinance à Luxembourg (CEREM-LUX)
- International Fund for Agricultural Development (IFAD)
- Microfinance Gateway
- United States Agency for International Development (USAID) Microenterprise Innovation Project (MIP)
7. Policy issues
Policy issues relating to rural finance are of major importance to IFAD, for many reasons:
- they reflect the up-stream dialogue and impact sought from on-the-ground rural finance programmes;
- they may affect the growth, institutionalization and sustainability prospects of RFIs (e.g. interest rates caps directly affect sustainability); and
- in a country where the microfinance industry has reached a critical stage, the existence of a coherent national government strategy may help strengthen this sector and preclude possible disruption.
Policy dialogue with governments concerning rural finance may actually achieve a major impact when IFAD intervenes for pilot rural finance programmes with a large-scale national institution (in China, for example).
The three sections below reflect policy areas of major importance to the Fund's operations, and provide some general guidelines for possible IFAD interventions in those areas. However, before entering into policy-related interventions, IFAD should assess whether it is best positioned to do so, and how it may cooperate with other donors and technical partners who may have the comparative advantage of a strong field presence or specific technical expertise. At the same time, IFAD's policy support role may also be important in helping to ensure that the needs and constraints of RFIs are fully taken into account in national policy dialogue, where they are often overlooked by regulatory authorities, who tend to focus more closely on urban financial institutions.
7.1 Consultation and Definition of National Strategies for the Microfinance Sector
Faced with a rapidly growing and still fragile microfinance sector, governments are increasingly aware of the need to support and regulate this area of financial intermediation. This concern has led to the definition of ‘national microfinance policies', which may be implemented within the framework of specific sectoral support programmes, or as components of poverty alleviation programmes. This approach is being launched or is under way in several countries, notably in Africa (Burkina Faso, Cameroon, Madagascar, Mali, Mauritania, Niger, etc.). The overall objectives usually include professionalization of the microfinance sector, and support to organization, for example, through the emergence of professional associations.
The challenge in defining – on a national scale – a national microfinance strategy is twofold: first, increasing coherence among the various national stakeholders, and, second, providing constructive support to consolidate and strengthen the sector. Successful examples (such as in Mali) underscore the need for prior, broad-based consultation on the part of all stakeholders (MFIs, NGOs, ministries, etc.). In that context, setting up an effective framework for dialogue is a slow and complex process. It includes coordinating a sector that is largely informal and poorly known, mobilizing various public authorities that are not used to working together, and establishing control mechanisms in contexts where access to and dissemination of information are already difficult. It is therefore essential to conduct an analysis of the sector before implementing a national strategy.
The following types of intervention could be initiated to support national microfinance strategies, with the focus of IFAD's support placed on the needs of RFIs:
- supporting the definition of a national policy, with regional consultation through workshops or seminars (including visits to or from other programmes, and study tours);
- adapting legislation, regulations, and licensing and control procedures;
- supporting services based on the sector's needs – such as databases, documentation centres, applied research, training for RFI management and staff, and setting up networks – through specialized providers or through the creation of streamlined, national or regional, service centres;
- providing suitable financial tools to support the expansion of networks and their services (equity funds, bank refinancing, etc.);
- supporting innovation and action-research by RFIs (e.g. on products and outreach mechanisms);
- strengthening the sector's regulatory structures through tools to help manage the development of competition, such as credit information bureaux; and
- assisting in improving communications in rural areas for the transmission of data.
7.2 Interest Rates and Fiscal Policy
The issue of liberalizing interest rates is vital for MFI viability. In many countries, the government wishes to control the rates charged by financial institutions, and the central bank sometimes imposes interest rate caps, as currently is the case in Western Africa and some countries in Asia, such as China, Laos and Viet Nam. Although these policies may be well intentioned – "helping poor people access affordable financial services" – it is now widely acknowledged that imposing caps on interest rates is counter-productive: it limits supply, favours the better-off clients and excludes the poor from access to a service they often badly need.
Some countries with interest rate caps may show a certain degree of tolerance for exceeding those caps, or may even acknowledge the need for higher rates in microfinance. A useful initiative for IFAD, and other donor programmes, could be to convince governments to lift those caps directly. This would eliminate the need for MFIs to charge a confusing battery of fees and expenses so as to achieve their targeted interest rate yield on loans.
What is important in such policy dialogue is to argue what will be the impact on the rural poor. Experience has shown over and over again that sustainable access to simple financial services, rather than the cost of those services, is seen by poor people as a key contribution to improving their livelihoods. The prospect of being denied such access because of government-imposed interest caps on loans may not be seen as a favour, but rather an injustice.
Fiscal policy vis-à-vis MFIs, and, notably, the possibility of MFIs obtaining tax waivers, at least during their initial years of operation, is also an important aspect of policy dialogue. Such waivers can help MFIs reduce their interest rates and improve outreach to their clientele, while maintaining the same sustainability targets. Where these concessions are part of a long-term government strategy they can play a useful role to the sector. However, if introduced on a short-term basis, they can be disruptive, since they create a short-term subsidy to the lending institution that encourages the setting of unsustainable lending rates.
7.3.1 Why regulate microfinance?
Regulating microfinance is justified by the state's determination to protect savers. Regulating the microfinance sector, however, raises the fundamental problem of conflict between two types of need:
- the requirements of the regulatory authorities, who seek normalization and simplification of practices (e.g. limiting the number of legal statuses, grouping isolated structures in networks to facilitate control); and
- the requirements of the sector itself, which defends a plurality of approaches and methodologies as a condition for responding to the diversity of situations and needs.
7.3.2 The risks of hasty regulation
The often very rapid growth of the microfinance sector, which usually presents itself as a new, informal and complex segment of the financial sector, contributes to government desires to regulate it. In addition, some MFIs frequently push for an appropriate legal framework to facilitate their institutionalization (e.g. disproportionate minimum capital requirements may prevent them from becoming licensed institutions).
While desirable in principle, the definition of a legal and regulatory framework should be set only after careful consideration, in order to reflect the sector's current and future needs. It should be considered only when the microfinance industry has reached a certain level of maturity in the country, with some MFIs ready to opt for deposit mobilization from the public and transformation into licensed entities. Conversely, premature regulation may result in putting constraints on the diversity and dynamism of local microfinance initiatives, with the risk of stifling innovation and hampering the future growth of this sector.
The most frequent example is "regulation by the legal status adopted by the RFI" (i.e. companies are regulated by a companies act, while cooperatives are regulated by a cooperatives act.). In some countries, MFIs have to adopt one specific legal status in order to operate. For example, a mutualist financial organization is the only legal vehicle recognized under the West African Economic and Monetary Union's (WAEMU's) Support Project for Regulations on Savings and Credit Operations (PARMEC). Such frameworks can be very constraining for MFIs that do not meet the required status, and may hamper diversity and innovation. They may also force existing institutions to adopt a legal framework that is not suited to their governance structure.
Finally, having specific regulations for different types of financial institutions increases the risk of dividing a financial sector into several categories, each having its own regulatory authorities. In Eastern Africa, for example, two of the financial sector's subsectors have a different type of supervision: MFIs come under the authority of the central bank, whereas cooperatives come under the authority of the Ministry of Agriculture. There may be some benefit to regroup supervision under the structure that has the comparative advantage and expertise to undertake this task.
In Cambodia, microfinance was launched by NGOs at the start of the 1990s. Today, there are almost 90 MFIs, among which two institutions Ennatien Moulethan Tehonnebat (EMT) and the Association of Cambodian Local Development Agencies (ACLEDA) have earned noteworthy and sustainable positions in the market (over 70 000 clients each). These two institutions have obtained legal status (EMT as a microfinance institution and ACLEDA as a commercial bank); eight other institutions were expected to be licensed by the central bank in 2002. This rapid development was unquestioningly encouraged by the fact that no government body questioned the freedom to set interest rates or established constraining regulations precociously. The authorities' interest in the microfinance sector grew, starting in 1995, and it is now a Government priority. The process for defining an appropriate regulatory framework was the object of in-depth discussions with the major donors and microfinance stakeholders. The banking law was passed by deputies in November 1999. A simple decree, derived from the banking law, was approved at the end of 2000, setting in a flexible manner the prudential norms, limits on activities, and supervision conditions for microfinance.
7.3.3 What type of regulation and supervision is appropriate?
It is important to acknowledge the vast diversity in the status of MFIs, from NGOs and coops, through banks, to other types of formal financial institutions, as well as in their size. It seems clear that many MFIs will not be able to become viable institutions, and even less be regularly supervised by bank supervision authorities, who are often not even able to supervise large banks efficiently.
This diversity implies that all MFIs cannot be treated in the same way. It also implies the need to:
- establish regulations in order to integrate and facilitate the growth of the largest institutions, in particular those wishing to mobilize deposits from the public (beyond mandatory microdeposits taken in connection with loans). However, it is necessary to allow sufficient time for compliance by small MFIs that are not yet able to meet supervisory requirements. The obligations placed on institutions must match their volume of activities, notably relative to mobilization of savings, and their level of sophistication;
- consider the appropriateness of further developing the idea of regulation ‘by activity' rather than by legal status. The intention is to focus more on elaborating norms for practising financial intermediation – installation conditions, ownership of capital, financial reporting requirements, respect for prudential standards, etc. – and less on the definition of specific legal status. For example, this is the principle applied to rural Indonesian banks, which can choose from among a variety of legal structures: a private limited company, cooperative, or other forms that are specific to Indonesia; and
- legislate in a simple manner, as passing laws is a cumbersome process. governments could often simply issue decrees or ministerial regulations, which have the advantage of being easier to modify, if need be.
7.3.4 Make supervision effective in practice
Even with an appropriate legal framework, the supervisory norms of the central bank – often inherited from the formal banking sector – can be unsuitable for microfinance institutions. Characteristically, the supervision of a large number of MFIs can be a very intensive and time-consuming process, bearing in mind, also, that those institutions represent a very small percentage of the assets of the national financial system. The supervision modus operandi, therefore, needs to be adapted to the specific characteristics of the microfinance sector, as well as to the actual monitoring capacity of the central bank. This is an important challenge, since supervision by the central bank implies de facto that it shoulders some responsibility for the soundness of the MFIs supervised – something that can have major consequences in the case of bankruptcy.
To make supervision operational, it is necessary to:
- work on defining an appropriate methodology (probably ‘risk-based', in contrast to that used for classic banks);
- train supervisory staff; and
- encourage MFIs (regardless of size) to set up internal procedures and rules to improve performance and governance, and be able to report to the regulatory authorities. These efforts can be facilitated by disseminating information in parallel with theestablishment of national regulations, MFI staff training, etc.
In this regard, IFAD should focus its attention on the impact on the rural financial sector of any policy that is adopted.
7.4 Internet Resources for Further Reading
- Consultative Group to Assist the Poorest (CGAP)
- Center for Institutional Reform and the Informal Sector (IRIS), University of Maryland
- International Food Policy Research Institute (IFPRI)
- OSU Rural Finance Program
- Pact's Small Enterprise and Microfinance Programmes
8.1 Evolution in Approaches to Microfinance Institution Impact Analysis
As stressed in IFAD's strategic framework, great emphasis has been placed on monitoring the catalytic impact of intervention, both at the field level and in relation to its policy dialogue and advocacy role. This applies equally to rural finance, where the prime objective of IFAD programmes is to improve the lives of the rural poor by providing them with sustainable access to a variety of financial services, including savings. In that context, being able to better assess the impact of its rural finance programmes on the lives of the rural poor has become an important priority for IFAD.
The rapid development of microfinance, the hope it inspired as a tool for poverty alleviation, and the magnitude of funds invested, led quickly to questions regarding impact. In the narrowest sense, impact assessment of actions or activities consists of understanding, measuring and assessing their effect. In the case of MFIs, impact analysis is the study of interactions and relationships of cause and effect between MFIs and their surroundings. This question is a complex one. The effect of MFIs can be both direct and indirect, felt at different levels (by individuals, households, various institutions, villages, the local economy, the region, and even the country) and in different fields (economic and social impact, health impact, etc.). Methodological difficulties are considerable. Two conceptual dimensions stand out: the fungibility of credit, as it is often difficult to determine specifically for what loans were actually used, once the funds entered household budgets, and the difficulty in attributing effects, because is an observed effect due to the credit or to other factors present in the socio-economic milieu? The approaches and methods of analysis currently in use have evolved in response to this complexity.
The first impact assessments at the end of the 1980s endeavoured to prove impact by a combination of scientific methods, tools and rigour. These studies, usually conducted by university teams, required large survey schemes, and proved to be long, costly and not very practical for use by microfinance operators.
Another movement developed minimalist approaches to impact assessment, based on the assumption that if an MFI grows and has satisfactory repayment rates, its clients must be satisfied with its services – thus, it can be said to have a positive impact. Therefore such impact assessment consists mainly of analysing the growth dynamics, client retention rate and performance of MFIs, without investing further in client studies in depth.
This second – minimalist – approach showed its limits as soon as the microfinance sector was confronted with crises. Arrears, client drop outs, bankruptcies and increasing competition led MFIs to ask themselves how well their services matched the needs of their target groups, and what were the potential causes of the breakdowns in the system.
Impact assessments today no longer seek to prove impact specifically, but rather try to identify the types of clientele that approach the MFI, understand how clients use its services, and identify client needs and constraints, in order to improve the services of the particular MFI. In addition to providing knowledge, impact assessments – in their various forms – can become tools to steer MFIs policies and innovations, such as new product development or outreach mechanisms.
Assessment methods also have evolved in recent years. Today, the orientation is towards less cumbersome, more operational and less costly methods that can be mastered more easily by operators, who can either conduct the assessments themselves or be closely involved in their implementation by local experts. A relatively wide range of tools now exists for this task, based on classical impact assessment and marketing approaches, with clientele and market analysis. Even if the goal is no longer to prove impact, scientific rigour remains necessary for these tools to provide as faithful an image as possible of quite a complex reality.
Today, particular attention is given to impact monitoring, which implies approaches that enable MFIs to conduct ongoing monitoring of a limited number of impact criteria.
8.2 Examples of impact assessment methods and tools
Examples are given below that highlight some methods and tools that can respond to IFAD's specific concerns regarding the impact of its rural finance programmes. The following tables give a brief description of some methods and tools, and their advantages and limits.
8.2.1 Client poverty measurement methods
|Table 1. Assessing the Relative Poverty of Microfinance Clients: A CGAP Operational Tool|
|Objective||A rapid, reliable, simple and inexpensive tool to asses the relative poverty of MFI clients; it determines the standard of living of households that have access to MFIs, compared to that of non-clients.|
Comparing new MFI clients to non-clients in the same area.
Elaborating a relative poverty index that shows the poverty status of households in relation to the sample as a whole.
Various dimension of poverty are taken into account: family structure, food, housing, other goods.
Rapid surveys of a sample of clients and non-clients.
Data analysis using Statistical Package for the Social Sciences™ software (multivariate statistical analysis).
|Who can conduct the survey?||
Assessors from outside the MFI.
Possibly the MFI itself, if it has staff trained in statistical analysis.
|Duration||Two months for the survey, six months to obtain results.|
|Cost||USD 10 000 to 15 000.|
Simple, rapid, inexpensive, easy-to-use (manual available on CGAP Web site).
Makes it possible to take into account several dimensions of poverty.
Makes it possible to assess the MFI's poverty outreach in the given area.
Applies to new clients only and not to the MFI's entire client portfolio.
Gives a view of relative poverty compared to the national average (comparison between different areas is difficult).
|For more information||CGAP Web site|
|Source: C. Lapenu|
|Table 2. Poverty Measurement Tool Kit|
|Origin||Micro Credit Summit|
|Objective||Identify the ‘poor' target population; and distinguish different categories within the ‘poor' population (‘very poor', ‘medium poor', etc.).|
|Method||Implemented in a given village, with two indexes used to place the households in the village within a local poverty scale.|
|Cashpoor House Index for Rural Asia||Participatory Wealth Ranking|
Index elaborated for a given area, based on a ‘housing quality' criteria.
Different characteristics of houses are taken into account (size, quality of the material used for the roof, walls, etc.).
Each household is graded according to the quality of the home. The households with well-off homes are excluded by an initial selection. The households with poor homes are then the object of a rapid survey of their production means (land, equipment, means of transportation, etc.).
Index elaborated for a given village through an assembly of resource persons, assisted by facilitators:
Establishes a map of the village.
Lists the households in the village.
Ranks the households according to wealth categories.
An index is calculated, based on the criteria used by the group to rank poverty.
|Who can conduct the survey?||
MFI team, with a supervisor (branch manager level) and loan agent facilitators.
Initial training is required in using the method.
|Duration||Example: Poverty wealth ranking survey of a 500-household village requires 1 supervisor + 3 facilitators (7 person-days).|
|Cost||7 person-days + USD 50.|
Makes it possible to quickly draw up a list of the poor.
Low cost, and can be used by the MFI.
Poverty ranking elaborated locally with the population.
The preparatory work with the groups makes it possible to generate a great deal of information on the area.
Not applicable in areas where housing is not an investment, or areas that have benefited from housing support programmes.
Does not take into account the non-material aspects of poverty.
It is a local poverty ranking, so impossible to compare different zones.
Group discussion facilitation is fundamental; poor facilitation can compromise fully the reliability of results.
|For more information||Micro Credit Summit Web site|
|Source: A. Simanowitz, Micro Credit Summit|
8.2.2 Methods inspired by marketing
The Participatory Rapid Appraisal method developed by MicroSave-Africa
|Table 3. Participatory Rapid Appraisal for MFIs|
|Objective||Allow practitioners to understand the complexity of households' financial, economic and social environments, and to better understand households' demands and constraints, how the MFI is seen by users and non-users, etc.|
|Method||Qualitative method based on discussions with groups of resource persons.|
The Participatory rapid appraisal tool provides discussion guides for 15 subjects, including:
– seasonal nature of income, expenses, savings and credit;
– seasonal nature of migration, temporary work, goods and services provided by the poor;
– life cycle profile to define cash needs over time;
– Venn diagram analysis on groups and organizations, and their roles; and
– poverty ranking.
|Who can conduct the survey?||
Specific training by MicroSave-Africa is needed to implement these tools.
|Duration||Example: A survey implemented in Bosnia required 4 people for 10 days + significant time for preparation and training.|
|Cost||Person-days + cost of MicroSave training|
|Comparative advantages||Makes it possible to generate high quality qualitative information rapidly, with the proviso that the staff are well trained and have mastered the group discussion techniques.|
It is not a tool intended for improving impact.
Considerable investment in training is needed, but not wasted for the MFI, because such methodology can be used on a day-to-day basis and integrated into the MFI's steering tools.
|Source: B. Brusky, MicroSave-Africa|
|Table 4. Learning from Clients: Assessment Tools for Microfinance Practitioners|
|Origin||AIMS – USAID, in collaboration with Small Enterprise Education and Promotion (SEEP) Network.|
Impact and clientele analysis tools to prove impact and improve MFI programmes.
A combination of five tools:
1. Main impact.
2. Reasons for exit.
3. Loan use and savings strategies.
4. Client satisfaction.
5. Client empowerment (women).
Tool #1: Main impact
Tool #2: Reasons for exit
Tool #3: Loan use/savings strategies
Tool #4: Client satisfaction
Tool #5: Client empowerment (women)
The five tools can be used together or separately.
|Who can conduct the survey?||
Local teams with experience in surveys and data analysis.
MFI staff with experience in surveys and data analysis.
250 to 300 person-days are needed, with results obtained in approximately three months.
|Cost||Approximately USD 18 000 for a complete assessment by a strictly local team; higher cost when international assistance is used.|
Relatively easy implementation at limited cost.
Accessible for practitioners.
|For more information||Web site|
|Table 5. Impact Analysis Based on Population Typologies|
|Origin||French approaches to impact within Comité d'échanges de réflexion et d'information sur les systèmes d'épargne-crédit (CERISE), comprising the Institute for Research and Implementation of Development Methods, CIDR, the International Cooperation Centre on Agrarian Research for Developmentt (CIRAD) and the Research and Technological Exchange Group (GRET).|
The purpose of these studies is to gain a better understanding of the impact of an MFI on the various population categories in a given area and to analyse the ways in which these groups use loans.
Survey of member and non-member households; systematic analysis of household operations (strategies, constraints, etc.); data treated by population typology.
Survey of a large sample of the population in areas that are representative of the diversity of the MFI's area of intervention.
Population typology defined based on a combination of levels of wealth and activity systems (multivariate analysis).
Comparison between access to and use of financial services by the various population categories can be combined with:
qualitative surveys of a smaller sample of households to deepen analysis of householdstrategies, constraints and credit use; and
a monograph on the MFI.
Possibility of deeper study using repeat surveys at regular intervals to follow a reduced sample of households (monitoring household budgets, cash flows, etc.).
|Who can conduct the survey?||Local teams that are skilled in surveys and data analysis.|
|Duration||Varies according to the combination used. For the basic survey, data collection = 60–80 person-days; analysis = 60–80 person-days.|
|Cost||Approximately USD 20 000 for a strictly local team.|
|Comparative advantages||Enables detailed analysis by population category, and provides deeper understanding of household strategies and use of the MFI's services as a function of specific local constraints.|
|Limits||Does not help in improving impact. Regular repeated monitoring is a way of extending methodological limits, considering fungibility and attribution.|
|For more Information||E-mail: Cerise@globenet.fr|
8.3 Cross cutting themes developed in IFAD rural finance decision tools
Funding agricultural needs through RF programmes: how can IFAD better address the funding of agriculture-related activities through its RF programmes? There is considerable documentation, and a strong consensus among donors, regarding the failure of past government-led and subsidised agricultural lending practices. There is much less information available, however, regarding those successful experiences in microfinance that have provided agricultural financial services on a sustainable basis, in particular to marginalized rural households. How can innovation be promoted in this field, and what are the key issues to bear in mind when doing so?
The role of state-owned banks and formal financial institutions in RF: Should IFAD work with them, and how? There is a large consensus regarding the failure of state-owned banks (SOABs), and especially state-owned agriculture banks (SOABs), to provide financial services to the poor. In this context, IFAD's Policy Paper rightly advocates discontinuing the provision of large credit lines to these institutions. However, through their large rural networks, their ability to mobilize savings, and their fund transfer systems, SOABs in principle may have a strong comparative advantage in reaching very large numbers of poor rural dwellers in a cost- effective manner. In this context, is there scope for IFAD to continue working with these institutions on a different basis? How could pilot programmes be tested and what are the key conditions and requirements to be met?
Savings and remittances: Savings have been called the "forgotten half of microfinance". There has been a growing awareness within IFAD of the key role played by savings in RF - especially with regard to reaching the very poor, who may lack investment opportunities but greatly value access to savings services. Research and pilot programmes (i.e. MicroSave) have shown that access to safe and flexible savings services can play a critical role in poor people's strategies for minimizing risks, can mitigate income fluctuations and build a small asset base over time. However, mobilizing savings implies risk as well as placing specific responsibilities on RF institutions, donors and governments. The Decision Tools look at the key issues that need to be addressed when supporting savings mobilization.
How to extend the RF ‘frontier': how far can IFAD extend its RF operations into remote rural areas while, at the same time, promoting institutional and financial sustainability? What are the innovations that can help IFAD extend the frontiers of its interventions in rural areas?
Balance between funding capacity building / technical assistance, and providing loan capital: IFAD has started moving away from projects that provide very large credit lines, and is recognising the importance of funding capacity building and technical assistance for its RF partners. However, balancing these interventions in the most effective manner still remains a challenge, and is discussed in this section.
The role of participation in RF programmes: IFAD's Policy Paper places strong emphasis on the value of participation as a means to empower the poor, both in product design and in the management of rural finance institutions (RFIs). However, the concept of participation reflects very different realities, depending on the local context and type of RF institution concerned. This section analyses what participation means in the different contexts, and the way in which IFAD may reflect the appropriate level of participation through its various types of interventions.
RF Policy Issues: IFAD faces major policy issues in most of its RF interventions. For example, at what point should it consider designing a national RF strategy as opposed to a more ‘operational' project? How should the Fund deal with the challenges concerning the regulation and supervision of RF institutions? How could it best reflect policy issues in its RF operations?
Impact analysis: IFAD is facing increasing pressure to better document the impact of its RF programmes. Are its interventions reaching the poor and the very poor? Can one assess the impact of IFAD projects on the life of its RF clients? What types of impact assessment tools exist, what are their characteristics and how can they best fit the Fund's needs and requirements for impact assessment?
8.4 Internet resources for further reading
- Consultative Group to Assist the Poorest (CGAP)
- International Food Policy Research Institute (IFPRI)
- Microcredit Summit
- Microfinance Gateway
- Pact's Small Enterprise and Microfinance Programmes
- USAID Microenterprise Innovation Project (MIP)