Finance for Poor: Note on Microfinance

What is microfinance?
The term microfinance refers to the provision of financial intermediation services to clients having low incomes. These services include savings and credit; and in some cases, also insurance. Along with financial intermediation, many Micro Finance Institutions (MFIs) help their clients in group formation and provide basic training on accounts and financial management, which are collectively referred to as social intermediation services. Microfinance clients are typically self employed low income people in both rural and urban areas.

Microfinance has evolved as a development approach intended to benefit the economically underprivileged. While its impact on poverty reduction is an issue of debate, microfinance does play a significant role in increasing the access of financial intermediation services to the poor people, which in itself is a laudable development objective.

What do microfinance operations usually involve?

• Making small and flexible loans according to clients’ requirements, repayment capacities and cash-flows
• Providing secure deposit facilities to the poor, which allows them to save as and when they have surpluses
• Collateral substitutes such as group guarantees and compulsory savings
• Encouraging repeat and larger loans based on repayment performance
• Continuous monitoring and follow up to ensure timely repayments of loans

What are the organizational forms of MFIs?
MFIs have been organized as Not for Profit Organizations (NPOs), savings and credit cooperatives, credit unions, financial services associations, specialized rural banks and non-banking financial companies. Their institutional forms have implications on issues like accepting clients’ deposits, intermediation of these deposits, capital structure, taxation, statutory disclosures and compliances.

What are the different methodologies used for providing micro-financial services?
These methodologies can be divided into individual approach and group based approaches. While individual banking approach involves provision of financial services to client who are not members of any group that is jointly responsible, the group based approaches (which involves lending to either groups or members who are organized as groups) utilize peer pressure and group guarantee to ensure desirable client behavior such as timely repayment of loans.

There are many variants of the group approach which includes Grameen Bank (pioneered by Dr Mohammed Younis) solidarity lending, Latin American solidarity group lending and the Indian Self Help Groups (SHG)-bank linkage.


What are the features of a sustainable MFI?
• Clear understanding of target market and services offered
• Business planning to reach specific strategic objectives
• Market based financial services
• An ability to undertake quick client selection, training and financial service delivery
• Appropriate organizational structures and trained staff
• Standardized and documented operational procedures widely understood by staff
• Transparent, timely and accurate accounting
• Regular audits – both internal and external
• Realistic budgeting and financial projections
• Functional Management Information Systems (MIS) which provides timely, accurate and adequate information on key performance indicators and allows the management to make informed decisions
• Legal registration and compliance with supervisory requirements
• Economically feasible scale of operations to cover all costs through the available interest spread

What are the promises and what are the caveats?
Promises
• It holds the promise of reaching the poor
• It holds promise of building financially self sufficient locally managed institutions
• It can contribute to strengthening formal financial systems
• It can build on traditional systems

Caveats
• Productive credit would have little use if the target population has little access to business opportunities
• Reaching a sustainable scale of operations is often a big challenge for many MFIs
• The legal and policy framework may also be a constraint in providing effective microfinancial services
• Inadequate fund management may create liquidity problems for MFIs