Size of Loan

What is the size of a microfinance loan and what determines the size of loans? Various studies have tried to estimate the size of microfinance loans. For instance, Buyske (2004) says microloans range between $300 and $1000. Christen, Lyman and Rosenberg (2003) recommend that only an upper limit should be set for a microloan and that loan size decisions should be based on borrower‘s character and cash flow. Ledgerwood (1999) also urges microfinance institutions to consider cash flows as well as service users‘ ability to repay

15 _{In the staggered method group members receive loans in stages. Some members of a group receive their loans}

and if they repay then other members are eligible to take their loans.

56 loans in determining loan size. Debt capacity16 rather than credit need17 is deemed as an important criterion for loan assessment for service users. The socio-economic status of service users and the environment in which the intervention operates (rural/urban) have been found to be important determinants of size of loans. Parsini and Yoskowitz, (2005) and Painter and MkNelly (1999) all found that loan size was positively associated with urban location. Seasonality and market constraints were also found to be important determinants of loan size especially in rural communities. Godquin (2002), in a study in Bangladesh found that wealthy borrowers received bigger loans. Gaiha (2001) also found in study in rural India that wealthier beneficiaries received about twice of what went to the poorer beneficiaries. Level of education and age also showed a positive effect on loan size. WWB (2003) assessed service users‘ satisfaction with loan size in Bangladesh and Uganda. They found 34% and 27% of service users in Bangladesh and Uganda respectively were dissatisfied with the smallness of loan sizes.

The size of microfinance loans is also determined by the orientation and ideas of microfinance interventions. First, some microfinance institutions provide small loans based on the assumption that it will be demanded by only poorer service users. In other words loan size serves as a proxy indicator for the level of poverty of microfinance service users (Schreiner, 2001). However, Dunford (2002) argues that while it is evident that the poor cannot take large loans, there is no corresponding evidence that only the poor apply for small loans. Better-off service users can and do borrow small loans to ease cash flow problems and to begin additional income-generating activities. In spite of Dunford‘s finding it is argued that smallness of loan sizes in addition to other mechanisms have been used to prevent the relatively well-off people from hijacking smaller loans destined for poorer people. Hulme and

16 _{Debt capacity is the amount of additional debt a service user can bear without running the risk of default.} 17

Ledgerwood says credit need assessment is quite unreliable because it involves self-reported information which contains ‗want‘ that does not take debt capacity into consideration.

57 Mosley (1996) have noted that other factors such as the very public nature of financial transactions and group meetings significantly contribute to deterring the non-poor from accessing small-sized loans.

Second, many microfinance institutions usually begin with smaller loans and, depending on repayment performance, steadily increase the size of loans. This is called the dynamic incentive strategy (Hulme and Mosley, 1996; Johnson and Rogaly, 1997; Godquin, 2002). SafeSave discovered that an important contributory factor to bad debt was the offering of overly large first loans (Staehle, 2005). In addition to preventing loan default, microfinance institutions make initial small loans and demand the prompt repayment as a means of stimulating productive use of microcredit. This technique is important if bad debt reflects the inability of poor households to make productive use of credit (ibid).

Third, changes in loan size have also been used to measure of changes in level of poverty of service users. For example, Painter and MkNelly (1999) used the ability of service users to work and repay progressively larger loans as a proxy indicator for viability of service users‘ income-generating activities and reduction in poverty. This method of assessing impact of microfinance intervention has been much criticised. The use of dynamic incentive strategy by most microfinance interventions makes it difficult to ascertain whether increased size of loans was due to routine increment (dynamic incentive) or as a result of viability of service users‘ income-generating activities or reduction in poverty. Loans, on the other hand, are known to be used for other purposes other than income-generating activities and therefore increased demand for loans might not be linked to business viability or reduction in poverty.

58 In sum, there seems to be no consensus on what constitutes the optimum size of a microfinance loan. The size of a loan should depend on the context. Since microfinance services are offered to poor people who have no access to orthodox financial services, loans are likely to be relatively small. Wealthier service users are more likely to demand bigger loans and so are urban dwellers. Small-sized loans have been used as instruments to prevent default, target the poor, and controversially measure changes in level of poverty.