5 Microfinance: An Overview
5.2 Target Groups of Microfinance
Microfinance mainly targets two groups: own-account or self-employed workers, and women living at the BoP. Microfinance clients are normally own-account workers living at the BoP, wanting to get economically active. The International Labour Organization’s (ILO) defines the term own-account worker as
a person who operates his or her own economic enterprise, or engages independently in a profession or trade, and hires no employees. (United Nations Statistical Office 1990, lit. b)
Although microfinance clients work alone for the most part, they sometimes do have a few people they employ. Since microfinance clients cannot be ruled out to have employees, I use the term self-employed interchangeably with own-account worker. Self-employment jobs are defined as follows:
Self-employment jobs are those jobs where the remuneration is directly dependent upon the profits (or the potential for profits) derived from the goods and services produced (where own consumption is considered to be part of profits). The incumbents make the operational decisions affecting the enterprise, or delegate such decisions while retaining responsibility for the welfare of the enterprise. (ILO 1993, art. 7)
Own-account or self-employed workers run microbusinesses, and might work as street vendors, seamstresses, hairdressers, or farmers.
Microfinance is further renowned for having a focus on women. Women constitute the majority of microfinance clients. Summarizing the latest numbers, which are from 2012, we look at the following figures of clients reached: The State of the Microfinance Summit Campaign Report indicates that 3’718 MFIs reported a total number of 203.5 million clients that had a current loan. Of these 203.5 million clients, 74.9 percent are women. Looking at the poorest clients reached, the total is 115.6 million, of which 83.3 percent are women (Reed 2014, table 1). In summary, there are five reasons why microfinance is mainly concentrating on women. These reasons
can be categorized as being motivated from a business (I-III) or poverty alleviation perspective (IV-V).
I. The commercial financial sector in developing countries traditionally discriminates against women, which results in no access or difficulties in obtaining access to credit or other financial services (UNDP 2013, 5–6; Armendáriz and Morduch 2010, 212). Banks widely focus on male clients and back formal businesses. This translates into a negligence of women on the one hand and the informal sector where most of the world’s poor try to make a living on the other hand. Women constitute 70 percent of the world’s poor and microfinance takes advantage of that in almost exclusively providing financial services to women working in the informal economy (Bureau for Gender Equality and International Labour Office 2008, 2).
II. Research of the 1990s showed dramatic differences between men and women in regard to access to resources (e.g. rights and liberties, decision-power, access to money, social relationships, jobs), results revealed that women were the clear losers in contrast to their male counterparts. Women however have considerable potential, which they could invest into an income generating activity (Dobra 2011, 134–135). Neglecting informal businesses thus results in overlooking a big and increasing segment of potential female clients. MFIs therefore gain access to a large market.
III. Women simply report higher repayment rates in regard to borrowed money than men (Gibbons, Kasim, and Ikhtiar 1990; Khandker, Khalily, and Khan 1995).
IV. In contrast to their male counterparts, female borrowers invest a bigger share of their income into the household and family, including nutrition, education and health (Collins et al. 2011; Littlefield, Morduch, and Hashemi 2003, 1–2; Armendáriz and Morduch 2010, 5, 267–311; Hoddinott and Haddad 1995; Thomas 1990; Thomas 1994; Khandker 1998).
V. Granting women access to credit may reduce inequalities regarding gender and access to resources and might contribute to the overall improvement of the status of women in developing countries (Bureau for Gender Equality and International Labour Office 2008).
5.3
Microfinance Providers and Credit
The following chapters give a summary of microfinance providers and the core product of microfinance, which is credit. Firstly, different types of MFIs that offer a range of financial and sometimes also non-financial services are presented. Secondly, credit as the main service of microfinance is explained in more detail20. A strong focus is put on the principal-agent problems (i.e. adverse selection and moral hazard), arising when providing uncollateralized loans and it is discussed how MFIs manage these problems with specific lending methodologies.
5.3.1
Different Types of MFIs
Literature distinguishes between informal, semiformal and formal microfinance institutions. Informal institutions, for example private moneylenders, family and friends, Rotating Savings and Credit Associations (ROSCAs), constitute informal ways to purchase credit or save money and lack a legal status (Armendáriz and Morduch 2010, 67–68). In contrast,
semiformal MFIs have to register their operations with an official authority. Which authority is responsible depends largely on the type of institution (e.g. unlicensed MFIs, NGO, post offices, financial cooperatives, credit unions) and country regulations. Semiformal institutions are subject to other „laws and regulations than banks and other formal institutions“ (Isern, Donges, and Smith 2008, 115). In many countries, only financial institutions with a banking license may take deposits, hence most of the semiformal MFIs are credit-only institutions (Isern, Donges, and Smith
20
Other microfinance products, such as savings, insurance, and money transfer products as well as the variety of investors that may be involved in funding MFIs’ lending operations are summarized in appendix.
2008, 115). Formal MFIs are subject to the same laws and regulations as traditional banks. They are under the supervision of official authorities such as a financial market supervisory authority, a central bank and banking law in general. Formal MFIs may include microfinance oriented banks, agricultural banks, and regulated MFIs (Isern, Donges, and Smith 2008, 115).
5.3.2
Microfinance Products
Credit, savings, insurance and money transfer are counted among the core financial services a microfinance institution provides. Some MFIs also offer non-financial services such as training (e.g. financial literacy and health education programs), which is not considered amongst the main services of microfinance. MFIs offering training programs are normally referred to as doing ‘microfinance plus’21.
The following presents microfinance’s most prominent product22: credit. As described in Chapter 4.1 providing the BoP with credit is complicated, since there is a lack of collateral and information about the riskiness of the borrower. Accounting for this lack, it is explained in more detail, what specific lending methodologies MFIs apply to mitigate information asymmetries in the absence of conventional forms of collateral. A detailed description of credit products serves the purpose of this research in such a way that the knowledge about why MFIs use particular lending techniques later on serves as a foundation to understand that specific lending methodologies alone might not prove to be sufficient to protect microfinance clients from over-indebtedness.
21
I provide a detailed description of a financial literacy program of such an institution in Chapter 18.1.
22
The other services, such as savings, insurance and money transfer products are shortly discussed in the Appendix.
5.3.2.1
Credit
Microfinance’s most common product is microcredit. It targets financially excluded individuals or communities by supplying them with loans. Whereas all MFIs provide credit, not all MFIs, as mentioned in Chapter 5.3.1, offer the whole spectrum of financial services. The loan amount disbursed must be relatively small (i.e. not more than 250% of the averaging income per person and year) and the loan maturity is normally below one year (La Torre and Vento 2006, 44). Repayment schedules usually foresee monthly or weekly installments (La Torre and Vento 2006, 24). As mentioned above, interest rates are usually higher than in collateralized banking. The average reaches about 35 percent but can range from 17 percent in Sri Lanka to 80 percent in Uzbekistan (Kneiding and Rosenberg 2008, 1). The purpose of credit is to give the client the opportunity to get economically active with the money received. Microloans traditionally are not intended for consumption needs (La Torre and Vento 2006, 43). However, clients sometimes also make use of credit products for unforeseen events or consumption (Gonzalez 2008, 100).
In Chapter 4.1, I touched upon the issue of agency problems in microfinance. The following chapter now explains how MFIs make use of group- or individual-based lending to set incentives to overcome imperfect information problems between the MFI and the client and as a consequence manage to decrease default risks.