Microcredit and Microfinance Dr. Marco Elia, University of Turin - Italy Belgrade, 28th November 2007

Agenda Introduction – What is Microfinance? The Institutionist and the Welfarist approach Microcredit and Microfinance Commercial approaches implemented by international and domestic banks in microfinance

1. Introduction What is Microfinance? “The provision of small scale financial services to low-income people excluded from the formal financial system” Almost general agreement on this definition Commitment to provide credit Common concern for low income people

Unity of commitments and concerns 1. Introduction Unity of commitments and concerns It masks different approaches Different types of institutions, borrowers, delivery systems put (sometimes incorrectly) under the term “MICROFINANCE”

SPECIALIZED FIELD THAT COMBINES BANKING WITH SOCIAL GOALS 1. Introduction MICROFINANCE SPECIALIZED FIELD THAT COMBINES BANKING WITH SOCIAL GOALS

Institutionist approach (WB, CGAP, USAID) 1. Introduction Institutionist approach (WB, CGAP, USAID) Focus on Financial self-sufficiency (FSS) and institutional scale Welfarist approach Direct poverty alleviation among the very poor Jonathan Morduch(1998) “The Microfiance Schism”

Emphasis: FSS and breadth over depth of outreach 1. Introduction THE INSTITUTIONISTS Emphasis: FSS and breadth over depth of outreach Center of attention: The institution Main success index: achieve Financial Self Sufficiency (FSS)

THE INSTITUTIONISTS HAVE CLEARLY WON THE DEBATE TO DATE 1. Introduction THE WELFARISTS Emphasis: Depth of outreach Center of attention: Clients Accept and require subsidies Grameen Bank of Bangladesh THE INSTITUTIONISTS HAVE CLEARLY WON THE DEBATE TO DATE

PRACTICAL IMPLICATIONS 1. Introduction PRACTICAL IMPLICATIONS Different clients served Different methodologies Different institutional structures and financing

The Institutionist argument 1. Introduction The Institutionist argument Recognition of scarcity (potential demand cannot be met only by donors) Poverty reduction requires massive scale BEST PRACTICES: essential step for FSS, CAPITAL MARKET ACCESS and MAXIMUM OUTREACH TO POOR CLIENTS

1. Introduction The Welfarists Depth over breadth of outreach FSS desirable, not necessary Concerns that “profit-making MFIs” will lose their “social mission”

1. Introduction Microfinance must be integrated into the formal financial system Annual spending of the donor community on microfinance: $800 million - $1 billion per year (CGAP, 2004) Potential demand : 500,000,000 clients far exceeds the capacity of donor funding (World Bank)

1. Introduction .. a short history 1960s – 1970s : credit provided to rural farmers by many state-run dev. Institutions (RDIs) RDIs almost always failed Grant mentality High transaction costs Heavy corruption Limited impact BELIEF THAT LOW INCOME PEOPLE ARE UNBANKABLE The Institutionist approach is partially an outcome of these failures

1. Introduction June 2004: The Group of Eight (G8) endorsed the 11 key principles developed by CGAP (a consortium of 28 public and privaste member donors) at the meeting in Sea Island (Georgia) They intent to build a base a basic principles to support a diversity of approaches 2005 has been declared Year of Microcredit by the United Nations In 2006 Yunus and the Grameen Bank received the Nobel Peace Prize

1. Introduction Furthermore must be highlighted that: Major innovations came from highly subsidized MFIs The relationship focus on the poor and profit orientation is not always clear CGAP admits that the majority of the MFIs do not have the potential to be FSS in the near future For certain target groups the benefits of ongoing subsidization may exceed their costs

Agenda Introduction – What is Microfinance? The Institutionist and the Welfarist approach Microcredit and Microfinance Commercial approaches implemented by international and domestic banks in microfinance

2. Microcredit and Microfinance Lack of clarity in using the terms The two ideas must be clearly differenciated “ Microfinance is he provision of small scale financial services (Microcredit, Microsavings, Microinsurance, money transfer) to low-income people” MICROCREDIT IS A PART OF THE FIELD OF MICROFINANCE

2. Microcredit and Microfinance The term Microfinance was first introduced in the 1990’s as a transformation, or extension, of the already popular and successful poverty alleviating idea of microcredit The “first generation” of institutions (NGOs) delivered almost only credit Successful example of Bank Rakhyat Indonesia in providing savings accounts poor people

2. Microcredit and Microfinance Savings services are as important as loans All the financial services, and not just loans, help low income people to smooth consumption, stabilize income and protect against risks (Broadening of the concept of microfinance) Importance of money transfer services Training to client is a non-financial service CENTRAL ROLE OF CREDIT METHODOLOGIES

2. Microcredit and Microfinance Microenterprise Development, Microfinance and Microcredit

Agenda Introduction – What is Microfinance? The Institutionist and the Welfarist approach Microcredit and Microfinance Commercial approaches implemented by international and domestic banks in microfinance

4. Commercial approaches Direct (downscaling, MFI at the outset) vs. Indirect approach (Loans to MFIs, partnerships, etc..) Legal constraints mainly related to interest rates celings Evidence from the current practice around the world show a “dual approach” The potential for grow is huge especially for additional financial services besides credit (strategy of Bank Rakyat vs. BancoSol) The key constraint is the “lack of institutional and human capacity” (CGAP, Key Principles of Microfinance)

References marco.elia@unito.it Easton, T. (2005). The hidden wealth of the poor. Survey: Microfinance - The Economist, November 3rd 2005 Harper, M. and Arora, S.S. (2005). Small Customers, Big Market: Commercial Banks in Microfinance. New Delhi, TERI Press Meyer, R. and Zeller, M. (2002). The Triangle of MICROFINANCE: Financial Sustainability, Outreach and Impact. John Hopkins Press, Baltimore and London Morduch, J. (1999). The microfinance promise. Journal of Economic Literature, 37, 1569-1614 Morduch, J. (2000) The Microfinance Schism. World Development Vol.28, No.4, pp. 617-629 Shreiner, M. (2003). A Cost-Effectiveness Analysis of the Grameen Bank of Bangladesh. Center for Social Development, Washington University in St. Louis Silverman, R. E. (2006). A New Way to Do Well by Doing Good – Microfinance Funds Earn Returns on Tiny Loans To Poor Entrepreneurs Abroad. The Wall Street Journal, 5 January Yunus, M. (1998). Banker to the Poor: The Autobiography of Muhammad Yunus, Founder of Grameen Bank. The University Press Limited, London marco.elia@unito.it