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What is Microfinance: evolution, and practices?

It is rather frequent to hear the word "microcredit," often associated with other now everyday concepts, such as "fight against poverty," "help to the poor," "rich and poor countries." More rarely, the term "microfinance" is heard, so I will try to make a minimum of clarity. The concepts of "microfinance" and "microcredit" are linked but distinct. They address the same type of customer, recipient, or "excluded" or "non-bankable" people, but do not offer the same services.

The term "microfinance" is made up of two distinct words: "micro" and "finance." "Micro" means small in absolute terms as they are not relative, or regardless of whether they are compared to something else. While the term "finance" was born with a social purpose: to move resources from subjects who have them (savers) to individuals who need it. A fitting definition of microfinance is given to us by the World Bank: "microfinance concerns small financial services. Above all, credit and savings are offered, especially to people who deal with agriculture, fishing, or livestock, who manage small companies manufacturing, recycling, repairing, or selling products. Here you will learn about the microfinance and its practices.

1.2. The population targeted by microfinance

Today with the boom that microfinance is experiencing in many developing countries in the context of increasing liberalization and computerization of the activity, it covers a wide range of customers and players.

Microfinance institutions target developing countries, in particular the poor, women, rural dwellers, and micro-entrepreneurs in need of financing, particularly for equipment operations and the development of income activity.

Women are the priority target of microcredit institutions explains this enthusiasm for female customers. Today, multilateral organizations, governments, donors, and NGOs all share the same conviction: there is no possible development and sustainable without the participation of women as actors.

We recognize that they are the first victims of structural adjustment plans, notably due to the weakening of collective infrastructure. We also note that they allocate their income more to family well-being, and we deduce that it is better to address them. Finally, it is recognized that mixed programs tend to be diverted and monopolized by men. It is clear that in Asia, the Maghreb and the Middle East countries, women are the priority targets and that in Eastern Europe and Africa, the results are much more nuanced.

Thus, if we are interested in the case of the most famous institutions, we note 74% of women in the case of BancoSol Bolivia, 75% for Brac-Bangladesh, and 95% for the Grameen Bank. In West Africa (UEMOA), the clientele is mainly male (60% in 1999).

In South and East Asia, there is a rather normal or even marginal female clientele, 50% for Bank Rakyat Indonesia, and less than 10% for regional rural banks in India.

1.3. Microfinance financial products

Microfinance being considered as aid intended for people in financial marginalization, or even financial exclusion, different kinds of financial products adapted to these people.

1.3.1. Microcredit

It is the most important financial product offered by microfinance. It is a social assistance system that consists in granting loans of very small amounts to entrepreneurs or artisans considered as insolvent by the formal banking system, therefore not being able to have access to conventional bank loans.

It essentially tends to develop in developing countries to favor their economy by the realization of micro-projects (Yunus, 1997).

1.3.2. Solidarity microcredit

It consists of relying on a group mechanism generally made up of five borrowers in order to compensate for the lack of material guarantees from these individuals. Each is "joint surety" for the others in the sense that if one of the members does not repay his loan, the others must do it for him. The risk of non-reimbursement is therefore transferred to the group itself. Although the loans are granted personally, the penalties for non-repayment concern the group, they are often in the form of suspension of new loans.

Social pressure, therefore, means that everyone repays because none wants to be the one who penalizes the others, and they then have every interest in monitoring and ruling themselves out those who are likely to be unable to repay: high-risk borrowers.

This principle of group collective responsibility and this selection of members by the group itself solve the problem of asymmetry of information in the bank; that is to say its lack of information on borrowers, and reduce the risks of adverse selection, moral hazard, the cost of the audit, and allows better compliance with contracts.

This joint guarantee mechanism allows a very high reimbursement rate (close to 100%) and a reduction in transaction costs known to be significant.

Indeed, the fact that it is the members of the group who select the borrowers avoids the credit institution all costly research and analyzes to know information about its customers and thus allows it to save the costs of instruction of a file.

The other advantage of solidarity microcredit is its positive role in society with this solidarity mechanism, which makes it possible to create and develop links or even friendships within the solidarity guarantee group.

1.3.3. Individual microcredit

Here, the loan is granted to an individual, and no longer to a group, based on his ability to present guarantees of repayment and a certain degree of security of the institution granting him the credit. For a specific purpose, this type of credit is not possible to make free use like solidarity credit. It is used to finance a specific project.

This is why, unlike solidarity credit, the analysis of credit files and the guarantees presented by the client are of the utmost importance in the case of individual credit. The MFI is then directly in charge of selecting its borrowers; it no longer relies on a self-selection mechanism. Therefore, the granting of this credit depends on the customer's repayment capacity and its guarantees.

Regarding the repayment capacity, it depends on the relevance of its investment project. This project must be profitable; in other words, its rate of return is higher than the interest rate on loan. Then, the MFIs practice the same analysis that any banker carries out before granting a loan: general analysis of the family budget to know the expenses (recurrent or exceptional) and other household income.

But for microfinance institutions, these procedures are much more difficult to perform due to the differences in tools and information since most microfinance clients do not keep accounts; they still managed to adapt them.

It is then up to the loan officers to reconstitute these financial elements due to a questionnaire asked directly to customers. With regard to the guarantees to be provided, the material guarantee is essential. It provides security to the credit institution in the event of non-repayment, not having to exercise social pressure here. However, DC customers do not have these types of guarantees.

1.3.4. Savings

Equity capital and access to credit being one of the possible financial resources for the company or the household, savings also constitute an essential financial service in the same way as the latter. The agents must make a trade-off between savings and credit, and their choices turn to savings on the basis of four criteria.

Indeed, the lack of security can lead to losses, as was the case for deposits in the informal sector, where almost 99% of Ugandan saving households were affected by this loss amounting on average to 22 % of amounts saved.

The accessibility of savings services is also important and necessary, especially in rural areas where the bank or MFI is often not nearby. This is why some MFIs have created savings collection services in the main markets of a rural area or so-called "home" services through agents who come to collect deposits and make withdrawals at regular intervals.

Liquidity is also essential for clients; they have an absolute preference for liquidity, in the event of major family problems or investment opportunities; they must be able to react immediately. Finally, remuneration is a less important criterion but should not be overlooked all the same. Attractive rates of pay are always more attractive to savers. Aware of the importance of this tool, MFIs, therefore, offer a range of savings products, in order to attract as many clients as possible.

1.3.4.1. Compulsory savings

This is one of the conditions of solidarity microcredit; it is characterized by compulsory payments that must be made by the beneficiaries of a loan. Its amount, therefore, depends on that of the loan granted and must be paid before the granting of the credit, or at the same time.

It is returned to the borrower once the loan has been repaid, but the credits being often renewed, clients rarely see the color; this liquidity remains theoretical. This, therefore, represents for individuals a constraint and, above all, a cost of access to credit, rather than a financial resource.

It must be able to be mobilized if necessary, to be appreciated. But for the MFI, this is far from being a constraint. On the contrary, it allowed it to constitute a source of financing without collection costs and blocked, to have a guarantee easy to set up, to create a reserve fund.

1.3.4.2. Voluntary savings blocked

Blocked voluntary savings is the second type of savings product developed by MFIs.

It is a savings paid into a blocked account for a fixed period, which can range from a few weeks to several years. This account must be regularly remunerated.

MFIs appreciate it very much because it allows them to anticipate, plan, and manage the liquidity of deposits. Being blocked for a certain time, known to the institution, it is loaned to customers seeking credit.

1.3.4.3. Demand deposits and semi-liquid accounts

These are the most liquid savings accounts; they have no constraints; customers deposit and withdraw money as they see fit. However, microfinance institutions often impose limits on the number and amount of withdrawals; too many withdrawal movements, especially for small sums, impose too high management costs on the MFI.

In addition, another disadvantage for the MFI, demand deposits cannot be recycled into credits since they have no fixed term and can, therefore, be withdrawn at any time.

1.3.5. New financial products

The microfinance sector had changed considerably since the days when MFIs offered a single product, microcredit, intended for a single clientele, micro-entrepreneurs.

Today, MFIs are able to offer more sophisticated financial products that better meet the needs of their different client segments. We will see some of these products here.

1.3.5.1. The Microinsurance

First of all, there is one that is complementary to credit and savings; it is micro-insurance. It is obviously aimed at the poorest, excluded from social protection systems. It allows them to protect themselves from the risks to which they may be exposed, where savings and microcredit are no longer sufficient.

Due to a large number of insured persons, who regularly pool small sums, large amounts committed by families can be covered. The MFI, for its part, derives a double advantage. It satisfies its clients and reduces their risk of default; their vulnerability is reduced.

The implementation of this product is complex, because it is often prohibited, depending on the country, for MFIs to carry out insurance activities, and they do not have the skills and financial capacity required.

This is why many MFIs simply distribute products that have been created by insurance companies, taking care of promoting them, and collecting the premiums.

For example, AIG Uganda is a subsidiary of the American insurance group American International Group. She set up a death insurance product, and eight years ago, she started to collaborate with a local MFI, FINCA Uganda.

This product was then adapted to MFI clients and it is now distributed by 26 MFIs. 1.6 million people benefited from this product. Today other insurance services are covered by the term "microinsurance" such as life insurance, health insurance, and livestock insurance.

1.3.5.2. Home loans

Housing credit is also interesting to know. This financial product is used to finance the housing of the poor.

But he knows many limits. Indeed, home loans turn out to be long-term loans and do not directly generate income. The household is therefore taken a part of its income in order to repay this credit.

As for MFIs wishing to offer this type of credit, they must be able to offer very long-term loans and therefore have the necessary capital. Unfortunately, this is rarely the case.

Concerning the guarantees, they are hard to set up because the inhabitants of the countries concerned do not have title deeds; therefore, the MFIs cannot apply the classic guarantee mode of housing credit, which is the pledge of the housing financed.

In addition, that of solidarity microcredit is not applicable either, due to the greater importance of the amounts and the longer duration of this type of credit.

As for interest rates, it is much lower in the housing sector. To overcome these difficulties, the State can provide support to MFIs by offering those grants and / or long resources at concessional interest rates.

1.4. Funding of MFIs

The financial autonomy of institutions has been a major issue from the start of the expansion of microfinance. The resources of microfinance institutions generally consist of donations/grants, member deposits, equity, etc.

The microfinance financing offer is, therefore, quite diversified and has experienced an interesting development with the relay that the market is gradually taking. It is quite complimentary but still insufficiently coordinated.

1.4.1. Donations and grants

As with any new business, MFIs in the start-up phase need capital resources accepting high-risk taking. These resources come primarily from non-profit sources such as donations or subsidized loans made by social organizations, such as charities and development agencies.

A good part also comes from investments in kind provided by non-profit organizations as well as by the founder members.

1.4.1.1. Donors

Donors have long been the main funders of the microfinance sector; as such, they played a central role in the emergence, development, and orientation of microfinance.

By donor, we mean organizations, public or private, whose objective is to support development actions through the provision of donations (called grants) or loans at subsidized rates (cost lower than the rate of the market).

As long as the MFI is not viable, subsidies compensate for its losses. Financing the growth of the credit portfolio can also be the subject of financing from donors: either by grant or by loans at concessional rates.

These direct interventions in support of MFIs are today rarer on the part of donors, who prefer to act at the level of the sector and its environment.

When they exist, grants are increasingly concentrated on specific technical subjects (information system, training) or on critical periods of development of already mature institutions (institutional transformation, for example).

Today's donors favor other modes of intervention than grants: loans to MFIs, participation in investment funds, guarantees for obtaining loans from local banks, or bond issue guarantees. These instruments are, by natureMicrofinance, reserved for institutions that have reached a certain degree of maturity.

Author: Vicki Lezama


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