Along with the 3 other pillars of development – democracy, education and infrastructures – microfinance is increasingly considered a key instrument in implementing effective and sustainable strategies in the fight against unemployment
- Jacques Attali, President of PlaNet Finance -
Micro-credit is used to describe small loans granted to low income individuals that are excluded from the traditional banking system. It is part of the larger micro-finance industry, which provides not only credit, but also savings, insurance, and other basic financial services to the poor. The term ‘micro’ stems from the relatively small amounts of money that are being borrowed or saved.
Click on the terms below to learn more about each one:
Source: (Micro Finance Index Exchange-2010)
According to the 2010 Arab Micro Finance report conducted by MIX
Although the MENA region is the second youngest microfinance sector in the world (following ECA), it has shown signs of maturity in recent years, characterized by the following developments:
- Increased diversity of financial service providers (banks, microfinance banks, non-bank financial institutions, service companies, and NGOs) Higher and deeper penetration levels A widening pool of experienced human resources Improved credit risk systems Proliferation of mezzo-level non-financial service providers and supportive infrastructure (such as: business development services, credit bureaus, rating agencies, regional and national networks)
- Introduction of supportive legal and regulatory frameworks and
- Greater level of commercialization with less reliance on donor funding
Within the region however, the microfinance markets are in different stages of development with Morocco, Egypt, Jordan, and Yemen showing higher levels of maturity when compared to younger markets in Iraq, Sudan, and Syria.
The major characteristics for microfinance in MENA are:
MENA MFI’s offer their clients loans using two specific lending methodologies; namely, solidarity group lending and individual lending. The choice of methodology offered by an MFI is often subject to a number of factors including the MFI’s social mission, available delivery channels, product pricing and risk factors, and client needs.
Most MENA MFI’s are not regulated as financial intermediaries by the financial authorities in their respective countries and are therefore limited in the products they can offer. As such, microfinance product offerings in the MENA region continued to be limited to credit for the most part. In particular, microenterprise (business) loans constituted the majority of loan portfolios. In recent years, however, MFI’s began to offer a variety of additional loan products including consumer loans, housing loans, education loans, seasonal loans, and Islamic loans, to meet the demands of their target populations.
Microfinance services in the MENA region continue to be delivered through conventional channels (i.e. fixed branch networks) for the most part.
The key policy-related issues and challenges that MENA MFI’s continue to face are the need to introduce microfinance-specific laws and regulatory frameworks to support the commercialization of the sector as well as a need to clarify the transformation process for MFI’s that were initially established as NGOs and are seeking to transform into new for-profit entities.
Supportive Infrastructure - Credit Bureaus:
As the microfinance sector in the region grows and matures and competition increases, various stakeholders have come to realize the importance of establishing a functional framework for sharing client information. In several countries in the region new credit information systems are under development as a means of risk management and maintenance of healthy portfolios. While the systems in Morocco and Palestine are public and hosted in and managed by central banks, in Egypt it has been based on a private sector initiative. MFI’s are included in these credit information reporting schemes and have to report to the credit bureaus.
Demand, Outreach and Scale:
The MENA region is home to approximately 370 million inhabitants of which at least 26 percent are estimated to be living on less than USD $2 / day. By any estimate, the supply of microfinance services in the region is modest, at best, especially when factoring in the limited provision of financial services beyond microcredit. Seventeen large MFI’s from the oldest markets in the region alone have a combined portfolio of USD 912 million, which represents 78% of the region’s overall portfolio and a similar proportion of outreach.
It is estimated that there are approx 6 million households eligible for a microfinance loan and that there is a gap of approx 3 million potential microfinance Customers for a total of nearly $3.5 billion in GLP.
Funding Structure for MENA MFI’s:
MFI’s generally have three main sources of funding to finance their growth: deposits, debt, and equity. Only a few markets in the MENA region (Sudan, Syria, and Yemen) currently allow for savings mobilizations while the remaining markets are hampered by restrictive regulations and current structure of the financial sectors.
Historically, MENA MFI’s main source of funding has been donated equity. In fact, the MENA region still maintains the highest capital / asset ratio in the world at 45 percent in 2009 compared to a global median of 23 percent. Most countries in the region have been increasing debt financing and decreasing dependence on equity. MENA received USD 787 million in cross-border funding in 2009, which represents both the lowest volume of funding and lowest percentage of total global commitments worldwide at 4 percent. Moreover, the region witnessed a slow growth in commitments with 4 percent compared to 17 percent growth in commitments globally.
Local Banks are playing a significant role in providing 61% of all external funding, but that remains at high lending interest rates. Expanding the sources of funding to quasi-commercial debt will be critical for growth. (Examples of interest rates in 2009: Egypt 10.48%, Yemen, 9.33%, Jordan 7.62%, etc..)
Financial Performance - Efficiency and Profitability:
Microfinance in the MENA region continued to be highly profitable in 2009. The region recorded the highest median return on assets (ROA) at 3.4 percent.
The region’s impressive profitability comes despite the fact that it has one of the lowest levels of financial revenue (22 percent) compared to its peers. While financial revenues are modest, portfolio yields are amongst the highest in the world at 25 percent. This combination was due to the fact that the region maintained a low ratio of gross loan portfolio (GLP) to assets, at 75 percent. Egypt and Yemen are particularly low, both below 70 percent, a sign that the markets are more conservative in investing their funding into lending activities.
Policies and Procedures in Place to Manage Social Performance:
An increasing proportion of MFI’s in the region recognized social performance management as an important part of operations. The high percentage of MFI’s (71 percent) that performed some variety of training on social performance topics reflects this. The most common topics for trainings were mission orientation, development goals, over-indebtedness prevention and communication with clients about prices.
Micro-finance has existed in various forms for centuries, and even longer in Asia, where informal lending and borrowing stretches back for several thousand years. However, the birth of ‘modern’ micro-finance is said to have occurred in the mid 1970s in rural Bangladesh. There, in the midst of a famine, Dr. Muhammad Yunus, professor of economics at the University of Chittagong, was becoming disillusioned with the abstract theories of economics that failed to explain why so many poor people were starving in Bangladesh.
A 27 Dollar Loan
Determined to find a practical solution, Yunus began visiting local villages. In one nearby village, Jorba, he found a group of 42 women who made bamboo stools. Because they lacked the funds to purchase the raw materials themselves, they were tied into a cycle of debt with local traders, who would lend them the money for the materials on the agreement that they would sell the stools at a price barely higher than the raw materials.
Yunus was shocked to find that the entire borrowing needs of the 42 women amounted to the equivalent of US$27. He lent them the money from his own pocket at zero interest, enabling the women to sell their stools for a reasonable price and break out of the cycle of debt.
Muhammad Yunus talking with borrowers of the Grameen Bank | Copyright © Grameen Bank 2006
The Grameen Bank
The Grameen Bank project, which translates literally as “Village Bank”, was born, and today works in over eighty-thousand villages with more than six million borrowers. In 2006 both Yunus and Grameen were awarded the Nobel Peace Prize for their work with the poor.
Inspired by the success of The Grameen Bank, the 1970s and 80s saw rapid growth in the number of new micro-finance institutions appearing around the world, many of them started by NGOs and funded by grants and subsidies from public and private sources. They demonstrated that the poor could be relied on to repay their loans, even without collateral, and hence that micro-finance was a potentially viable business.
A New Model
During the 1990s, the industry began to realise that it could not continue to grow at such rates while still relying on grant funding. As a result, many began to restructure themselves to attract commercial investors, adopting more formal business practices and working to improve their efficiency and sustainability.
The Formation of PlaNet Finance
1998 saw the formation of PlaNet Finance, a not-for-profit organisation whose initial objective was to use the internet and new communication technologies to reinforce the capacities of NGOs in various sectors. This soon evolved into the PlaNet Finance that we know today; an international NGO whose mission is to fight against unemployment by developing micro-finance.
The Entrance Of Major Players
As enthusiasm for micro-finance as a tool for unemployment alleviation increased, focus moved away from NGO models towards promoting a sustainable industry that could provide financial services to the poor at fair prices while offering a reasonable return to commercial investors. As well as the many micro-finance investment firms that exist today, several large banking institutions have also entered the industry, such as Credit Suisse, Deutsche Bank and Citigroup.
By the end of 2008, nearly $15 billion of foreign investment had been channelled into micro-finance institutions, the majority still from government development organisations such as the World Bank, but with large amounts arriving from a variety of private and commercial sources.
In recent years micro-finance has been the subject of various innovations and experiments, from leveraging the hugely popular mobile banking industry, where mobile phones are used to send and receive money, for the purpose of micro-finance; to the introduction of new loan products tailored to local contexts, such as machinery loans, harvest stock spaces, and cattle fattening loans.
Loan methodologies have also diversified, and the original model of supportive group loans pioneered by the Grameen Bank, which have become more complex and adapted to local realities. Currently, products such as micro-insurance and micro-savings, which previously took the back-seat to micro-credit, are seeing their popularity increase.
Towards The Future
The future of micro-finance is hard to forecast, but several estimates suggest that 500 million to 1,5 billion people still lack access to financial services that could strengthen their economic situation and improve their life conditions.
Additionally, 2.5 billion young people will become adults within the next ten to twenty years, and it seems uncertain whether the traditional working market will be able to absorb such demographic boom. The role of micro-finance and other alternatives ways to encourage and assist auto-entrepreneurship are likely to remain important in the global economy.
Informal businesses are the basis of economic life in the developing world. Markets in the centre of town are the main distribution centres, similar to supermarkets in the developed world, while street vendors take the place of our local shops and stores. Production of goods is usually local and artisanal, rather than large-scale industrialised. Part of the reason for this small geographic spread of activities is the lack of good transport infrastructure, lack of public transport, and relative high cost of private transportation.
A micro-entrepreneur is an individual who either runs, or works in, the small businesses that constitute the informal sector of the economy. These businesses can be in a variety of sectors and industries, ranging from agriculture, farming, or fishing, to transportation, small shops or stalls, food production, or artisans. The structure of these micro-businesses may be individual, familial or collective. Some individuals may be entrepreneurs by choice, while others have become entrepreneurs through necessity due to a lack of employment opportunities. Levels of unemployment can also differ from person to person, from the vulnerable non-poor to the very poor.
While micro-entrepreneurs are a very diverse group, they have one thing in common: they are unable to access financial services through formal routes, such as traditional banks, because they do not meet the requirements that many of these institutions set, such as minimum deposits, collateral, a steady income, or a proven credit record.
Today, more than 150 million people worldwide, served by more than 10,000 Micro-finance Institutions (savings and credit cooperatives, NGOs, micro-finance banks…) and commercial banks, benefit directly or indirectly from micro-finance activities. It is estimated that over 500 million entrepreneurs remain excluded from financial services.
Micro-finance Institutions (MFIs) are the organizations that offer micro-finance services and products to the poor. There are many different types: savings and credit cooperatives, NGOs, programmes established by international organisations, legally-recognized micro-finance institutions, and micro-finance banks, and their sizes greatly vary, from 100 clients to over 6 million clients for the largest. As well as offering basic financial services such as loan products, savings accounts, and insurance, many MFIs also provide non-financial services such as training and education, or specific programmes to combat local issues.
The types of micro-finance institutions vary almost as widely as the types of micro-finance clients they take on. Originally an industry dominated by grant-funded NGOs and charities, micro-finance institutions have become increasingly sophisticated and now attract investment from major commercial banks. To find out more about a specific MFI, please visit mixmarket.org
Micro-finance is based upon the notion of moving away from traditional aid towards a sustainable and viable industry; therefore interest charges are necessary to cover the costs of administering the loans. The interest rates charged by micro-finance institutions are often considerably higher than those offered by traditional financial institutions. This is because the cost of administering many small loans in rural areas is much higher than the cost of administering fewer large loans in developed urban surroundings.
In addition to normal operational costs, the interest rates must be able to cover:
- The cost of funding to the MFI – of ten higher in developing countries, as foreign funders will require a higher return to cover the additional risk of lending to micro-finance institutions.
- Exchange rate risk – of ten higher in developing countries; currencies may be volatile, illiquid, and inflation may be high.
- Risk of borrower default – higher as borrowers can rarely offer collateral or credit history.
- Administrative costs – compare the cost to your bank if you make a transaction at a branch or via the internet, versus the cost to an MFI of sending a loan officer weekly or monthly to collect repayments from a client in a rural village without a proper transport infrastructure. The latter is also likely to be a much smaller sum of money, making the transaction cost per euro or dollar much higher for the MFI.
This does not mean that all high interest rates are justifiable. It is important that MFIs are efficient and work to reduce their operating costs; this is something that the industry carefully scrutinises, and as the level of competition between MFIs grows, so does the pressure on them to reduce their rates.
So how are micro-entrepreneurs able to afford these interest rates? Several studies have been conducted in Mexico, India, Kenya and the Philippines, which have shown that the percentage return on investment is much higher for micro-enterprises than larger businesses, finding rates ranging from 117% up to 847%1,2.
In fact, Richard Rosenberg, senior advisor at the Consultative Group to Assist the Poor (CGAP), has suggested that there is overwhelming empirical evidence that huge numbers of micro-businesses are able to pay interest rates that would usually strangle larger businesses because the interest charge only makes up a small proportion of the input costs of the micro-business3, a view that is supported by research by Schmidt and Kropp (1987)4.
For a more in-depth look at micro-finance interest rates, we recommend reading this report by the Asian Development Bank.
- 1. CGAP (2004). ‘Interest Rate Ceilings and Micro-finance: The Story So Far’ Occasional Paper p. 9.
- 2. David McKenzie, and Christoper Woodruff (2007). “Experimental Evidence on Returns to Capital and Access to Finance in Mexico,” World Bank and University of California, San Diego.
- 3. Rosenberg R (1996) ‘Microcredit Interest Rates’ CGAP Occasional Paper p. 1.
- 4. Schmidt RH, Kropp E (1987). ‘Rural Finance: Guiding Principles’ Rural Development Series, BMZ/GTZ/DSE
Modern micro-finance has experienced rapid expansion and evolution, from its humble beginnings a few decades ago, to an instrumental tool in the fight against unemployment. These changes would not have been made possible without the involvement of others within the industry.
Financial backers act as a catalyst, helping new MFIs or micro-finance projects to initiate and grow their activities through grants or investment. The aim is usually for the institution to eventually become self-sustained, but this often takes years of investment before it becomes a reality. Financial backers are often either public institutions such as the World Bank, the European Commission, or private foundations and funders, such as Citigroup, Blue Orchard or Oikocredit.
P2P Micro-credit Websites
One of the latest innovations in micro-credit financing is the introduction of the general public through peer-to-peer micro-lending. Several websites have been launched in the past few years that use the power of the internet to enable the general public to support micro-entrepreneurs through loans.
Governments can determine the rate of growth of the micro-finance industry within their country through the regulations they enforce. Many regulations designed for the banking industry may not be appropriate for the micro-finance industry, and therefore can be restrictive unless sector-specific regulations are introduced. Governments often also provide financing to the micro-finance sector within their country, something which can be both positive and may also harm the industry, for example by discouraging private-sector delivery of services.
For more information on this topic, please read this CGAP article.
Rating Agencies such as PlaNet Rating and MicroRate analyse and report on the financial, organizational and social viability of MFIs. They contribute actively to improving the transparency of the sector, and enable potential funders to easily assess the risk of a particular MFI.