Fundamentals of microfinancing

The managers at the MFIs are careful to ensure the borrower success and informs about the risks involved, that makes in general the borrower performing better. This leads often to earned dignity and lasting self-confidence associated with responsible loan repayment. To have a sustainable growing economy it takes high entrepreneurship and energy in order to develop the world and fight poverty. Independent and responsible entrepreneurs are valuable resources which can take advantage of the microfinance industry. They will not take big risks and must be supported by predictable financing. Normal bank operations suits better to large transactions which is more profitable, the traditional operating philosophy is to invest in facilities and they have costly operating structures. The traditional financing industry must either change themselves or stay out of the microfinance business. A new generation of banking institutions is growing in a market of very small transactions and less affluent clients. With lowered transactions costs through institutional specialization and innovation in delivery systems, they will be able to operate profitable in this market serving the poor with financial services. The poor entrepreneurs are the future representing the population who will become successful in the nearby future. They have the same will and skills as the toughest business operators. The are economical, dont take big risks and repay debts as scheduled to maintain possibility borrowing money in the future. This require a totally new ground breaking banking system with scale economics. Modifying the standard system will simply not be enough, the poor people will continue stay outside their countrys economy. Building up microfinance institutions serving poor people is a relatively costeffective use of subsidies for economic development compared to other supporting strategies for welfare.

The definition of microfinance

Microcredit, or microfinance, is banking the unbankables, bringing credit, savings and other essential financial services within the reach of.millions of people who are too poor to be served by regular banks, in most cases because they are unable to offer sufficient collateral. In general, banks are for people with money, not for people without. (Gert van Maanen, Microcredit: Sound Business or Development Instrument, Oikocredit , 2004) (Microcredit) is based on the premise that the poor have skills which remain unutilized or underutilized. It is definitely not the lack of skills which make poor people poor.charity is not the answer to poverty. It only helps poverty to continue. It creates dependency and takes away the individuals initiative to break through the wall of poverty. Unleashing of energy and creativity in each human being is the answer to poverty. (Muhammad Yunus,

Expanding Microcredit Outreach to Reach the Millennium Development Goals, International Seminar on Attacking Poverty with Microcredit, Dhaka, Bangladesh, January, 2003) Microcredit belongs to the group of financial service innovations under the term of microfinance, other services according to microfinance is micro savings, money transfer vehicles and micro insurance. Microcredit is a innovation for the developing countries. Microcredit is a service for poor people that are unemployed, entrepreneurs or farmes who are not bankable. The reason why they are not bankable is the lack of collateral, steady employment, income and a verifiable credit history, because of this reasons they cant even meet the minimal qualifications for a ordinary credit. By helping people with micro credits it gives them more available choices and opportunities with a reduced risk. It has successfully enabled poor people to start their own business generating or sustain an income and often begin to build up wealth and exit poverty. The amount of money thats lended out seldom exceeds 100USD. Microcredit fits best to those with entrepreneurial capability and possibility. This translates to those poor who work in growing economies, and who can undertake activities that generate weekly stable incomes. For those who dont qualify because they are extreme poor like destitute and homeless almost every microcredit institution have special safety programs that offer basic subsistence and later endeavours to graduate this members in their microfinance program making ordinary microcredits available. Microcredit plays an important role in fighting the multi-dimensional aspects of poverty. Microfinance increases household income, which leads to attendant benefits such as increased food security, the building of assets, and an increased likelihood of educating ones children. Microfinance is also a means for self-empowerment. It enables the poor to make changes when they increase income, become business owners and reduce their vulnerability to external shocks like illness, weather and more. Microcredit has widely been directed by the non-profit sector while commercial lenders require more conventional forms of collateral before making loans to microfinance institutions. But now its successfully growing bigger and getting more credibility in the traditional finance world. Due to that the traditional banking industry have begun to realize that this borrowers fits more correctly in a category called prebankable. T he industry has realized that those who lack access to traditional formal financial institutions actually require and desire a variety of financial products. Now a days the mainstream finance industry is counting the microcredit projects as a source of growth. Before almost everyone where neglecting the success of microcredit in the beginning of the 1970s when pilot projects such as ACCION where released until the United Nations declared 2005 the International Year of Microcredit. The most of the microcredit institutions and agencies allover the world focuses on women in developing countries. Observations and experience shows that women are a small credit risk, repaying their loans and tend more often to benefit the whole family. In another aspect its also seeing as a method giving the women more status in a social economic way and changing the current conservative relationship between gender and class when women are able to provide income to the household. Women are in most cases responsible for children, and in poor conditions it results in physical and social underdevelopment of their children. 1.2 billion people are living on less than a dollar a day. There are many reasons why women have become the primary target of microfinance services. A recent World Bank report

confirms that societies that discriminate on the basis of gender pay the cost of greater poverty, slower economic growth, weaker governance, and a lower living standard for all people. At a macro level, it is because 70 percent of the worlds poor are women. Women have a higher unemployment rate than men in virtually every country and make up the majority of the informal sector of most economies. They constitute the bulk of those who need microfinance services. Giving women access to microcredit loans therefore generates a multiplier effect that increases the impact of a microfinance institutions activities, benefiting multiple generations.

History of microfinance
The history of microfinancing can be traced back as long to the middle of the 1800s when the theorist Lysander Spooner was writing over the benefits from small credits to entrepreneurs and farmers as a way getting the people out of poverty. But it was at the end of World War II with the Marshall plan the concept had an big impact. The today use of the expression microfinancing has it roots in the 1970s when organizations, such as Grameen Bank of Bangladesh with the microfinance pioneer Mohammad Yunus, where starting and shaping the modern industry of microfinancing. Another pioneer in this sector is Akhtar Hameed Khan. At that time a new wave of microfinance initiatives introduced many new innovations into the sector. Many pioneering enterprises began experimenting with loaning to the underserved people. The main reason why microfinance is dated to the 1970s is that the programs could show that people can be relied on to repay their loans and that its possible to provide financial services to poor people through marketbased enterprises without subsidy. Shorebank was the first microfinance and community development bank founded 1974 in Chicago . An economical historian at Yale named Timothy Guinnane has been doing some research on Friedrich Wilhelm Raiffeisens village bank movement in Germany which started in 1864 an by the year 1901 the bank had reached 2million rural farmers. Timothy Guinnane means that already then it was proved that microcredit could pass the two tests concerning peoples paybackmoral and the possibility to provide the financial service to poor people. Another organization, The caisse populaire movement grounded by Alphone and Dorimne Desjardins in Quebec , was also concerned about the poverty, and passed those two tests. Between 1900 to 1906 when they founded the first caisse, they passed a law governing them in the Quebec assembly , they risked their private assets and must have been very sure about the idea about microcredit. Today the World Bank estimates that more than 16 million people are served by some 7000 microfinance institutions all over the world. CGAP experts means that about 500 million families benefits from these small loans making new business possible. In a gathering at a Microcredit Summit in Washington DC the goal was reaching 100 million of the worlds poorest people by credits from the world leaders and major financial institutions.

The year 2005 was proclaimed as the International year of Microcredit by The Economic and Social Council of the United Nations in a call for the financial and building sector to fuel the strong entrepreneurial spirit of the poor people around the world. The International year of Microcredit consists of five goals: Assess and promote the contribution of microfinance to the MFIs Make microfinance more visible for public awareness and understanding as a very important part of the development situation The promotion should be inclusive the financial sector Make a supporting system for sustainable access to financial services Support strategic partnerships by encouraging new partnerships and innovation to build and expand the outreach and success of microfinance for all The economics professor Mohammad Yunus and the founder of Grameen Bank were awarded the Nobel Prize 2006 for his efforts. The press release from nobelprize.org states: The Norwegian Nobel Committee has decided to award the Nobel Peace Prize for 2006, divided into two equal parts, to Muhammad Yunus and Grameen Bank for their efforts to create economic and social development from below. Lasting peace can not be achieved unless large population groups find ways in which to break out of poverty. Micro-credit is one such means. Development from below also serves to advance democracy and human rights. Muhammad Yunus has shown himself to be a leader who has managed to translate visions into practical action for the benefit of millions of people, not only in Bangladesh , but also in many other countries. Loans to poor people without any financial security had appeared to be an impossible idea. From modest beginnings three decades ago, Yunus has, first and foremost through Grameen Bank, developed micro-credit into an ever more important instrument in the struggle against poverty. Grameen Bank has been a source of ideas and models for the many institutions in the field of micro-credit that have sprung up around the world. Every single individual on earth has both the potential and the right to live a decent life. Across cultures and civilizations, Yunus and Grameen Bank have shown that even the poorest of the poor can work to bring about their own development. Micro-credit has proved to be an important liberating force in societies where women in particular have to struggle against repressive social and economic conditions. Economic growth and political democracy can not achieve their full potential unless the female half of humanity participates on an equal footing with the male. Yunuss long-term vision is to eliminate poverty in the world. That vision can not be realised by means of micro-credit alone. But Muhammad Yunus and Grameen Bank have shown that, in the continuing efforts to achieve it, micro-credit must play a major part.

Micro Financial Institutions

Poverty is the main cause of concern in improving the economic status of developing countries. A microfinance institution is an organization that offers financial services to low income populations. Almost all give loans to their members, and many offer insurance, deposit and other services. A great scale of organizations is regarded as microfinance institutes. They are those that offer credits and other financial services to the representatives of poor strata of population (except for extremely poor strata). Microfinance is increasingly being considered as one of the most effective tools of reducing poverty. Microfinance has a significant role in bridging the gap between the formal financial institutions and the rural poor. The Micro Finance Institutions (MFIs) accesses financial resources from the Banks and other mainstream Financial Institutions and provide financial and support services to the poor. MFIs are the pivotal overseas organizations in each country that make individual microcredit loans directly to villagers, microentrepreneurs, impoverished women and poor families. An overseas MFI is like a small bank with the same challenges and capital needs confronting any expanding small venture but with the added responsibility of serving economicallymarginalized populations. Many MFIs are creditworthy and well-run with proven records of success, many are operationally self-sufficient. Various types of institutions offer microfinance: credit unions, commercial banks, NGOs (Non-governmental Organizations), cooperatives, and sectors of government banks. The emergence of for-profit MFIs is growing. In India , these for-profit MFIs are referred to as Non-Banking Financial Companies (NBFC). NGOs mainly work in remote rural areas thereby providing financial services to the persons with no access to banking services. The term transformation, or commercialization, of a microfinance institution (MFI) refers to a change in legal status from an unregulated nonprofit or non-governmental organization (NGO) into a regulated, for-profit institution. Regulated, transformed organizations differ from nonprofits in that they are held to performance and capital adequacy standards and are supervised by a financial authority, typically the central bank of the country where they are registered. A transformed MFI also attracts equity investors. The equity investors want to ensure that the values of their investments are maintained or enhanced and elect Board members who share a common vision for the new for-profit institution. Among transformed MFIs, varying classifications of regulated institutions exist, the strictest being banks rural banks and thrift banks followed by non-bank financial institutions. Different countries have varied names for these regulated MFIs. The microfinance sector consistently focuses on understanding the needs of the poor and on devising better ways of delivering services in line with their requirements, developing the most efficient and effective mechanisms to deliver finance to the poor. Continuous efforts towards automation of operations is steady improving in efficiency. The automated systems have also helped accelerate the growth rate of the microfinance sector. The goal for MFIs should be:

 To improve the quality of life of the poor by providing access to financial and support services; To be a viable financial institution developing sustainable communities; To mobilize resources in order to provide financial and support services to the poor, particularly women, for viable productive income generation enterprises enabling them to reduce their poverty; Learn and evaluate what helps people to move out of poverty faster; To create opportunities for self employment for the underprivileged; To train rural poor in simple skills and enable them to utilize the available resources and contribute to employment and income generation in rural areas. Many institutions practice microfinance, or raise funds for microfinance, including the following: Accion International ACDI/VOCA BRAC Enterprise Development International Five Talents International Freedom from Hunger Grameen Foundation Kiva Microfinance in Uzbekistan Microloan Foundation Microcredit Summit Campaign Microenterprise Access to Banking Services Omidyar-Tufts Microfinance Fund Opportunity International Australia ShoreBank Tameer Microfinance Bank Ltd Unitus World Council of Credit Unions XacBank SKS

Working method for microfinance institutions

The Grameen Bank of Bangladesh has developed a joint liability model that its MFIs are using suited for local conditions. When choosing a village the MFI conduct a comprehensive survey to brief the potential for operations and the local conditions in a village. The MFI are evaluating some key factors like village population, degree of poverty, road accessibility, political stability and safety. When a village has been selected, the MFI introduces its mission, methodology and the services they are offering. After the informational presentation interested women are gathered in group formations. They have to be in the age between 18 and 59. The women put them self together in groups of five to serve as guarantors for each other. Earlier experience has shown that a group of five persons is small enough to create group pressure between the members, enforcing them to be loyal to each other. In case someone of the group members are not able to repay the loan the group is big enough to help with the payments. The company does not influence the selection of group members nor the decision regarding the income generation activity nor the loan amount they intend to take. Group members must live close to each other and cannot be related to each other. If a borrower defaults on her loan, the entire group typically is penalized and sometimes barred altogether from taking further loans. This peer pressure encourages borrowers to be very selective about their peer group members and to repay loans in full and on time.

Then the group training begins, usually as a five day program. The purpose is to educate the members in the procedures of the financial products, delivery methods, calculation of interest rates, business development skills and how to sign their names. The members are also taught in quality management, to identify an income generation activity, how to set prices and how to market. They field staff also build a culture of credit discipline and collective responsibility. The field staff makes sure the members qualifies for the program and collect data for future analysis. Within the village, a center is created collecting the groups. The center is responsible for the payments of all groups, enabling a dual liability system. When the villagecenter is created the financial transactions can begin. The groups meet weekly in the villagecenter where they can discuss new loan applications, loan utilization, and community issues. The field staff of the MFIs conduct the meetings with rigid discipline in order to sustain the credit discipline of the group. All financial transactions are conducted during the meetings. Microfinance is a relatively new segment of the market economy that is why institutions created in this segment have short experience in their activities, and their personnel is not sufficiently experienced and qualified. Taking this into consideration, staff of these institutes is recommended to follow the internationally recognized principles of microfinance:

thorough examination of potential clients of the microfinance institution;

thorough estimation of business viability and also factors which can positively or negatively affect the results of work in specific conditions; thorough registration of documents and contracts related to loan issuance and microfinance services providing; keep in touch with client in combination with monitoring of the terms of paying a credit, interests payments and with the aim to find out potential and real problems; setting of interest rates for microfinance services compatible with market ones; quick reaction to any problems which can complicate the perspectives of getting of issued credit payed back.

Economies of scale
MFIs need both capital and internal operating capacity to achieve scale. Since 1970 microfinance has been proven to be one of the most effective and sustainable tools in povertyfighting. But still are 80 percent of the working poor, more than 400 million families, without reach of financial services. To be able to serve everyone the microfinance industry must be even more efficient and grow to scale. At today growth rates it will take decades for the rest 80 percent to be served.

The most critical problem today is finding money to lend out to the poor. Existing microcredit programmes are coming to a virtual halt in their expansion programme, and finding it difficult to continue their present programme because of lack of funds.

Many microfinance instituions are self-sustaining but most of the microfinance institutions still rely on and must get rid of their dependency on donor money in order to reach scale. Large amounts of money is needed to expand their operational capacity in order to reach economies of scale rapidly. Without sufficient internal operating capacity growth suddenly stops once a program reaches several thousand clients. They must provide their financial products to a much bigger amount of clients. The only possibility to access large amounts of money is on the traditional financial market. The problem for most MFIs to attract this money is the lack of track record and well formed business plans. The keysolution to the right internal operating capacity includes improving for example the information technology, internal controls, new product development and human resources. When MFIs rely to much on donor money its very hard to do the necessary investments in the areas that are sustainable and with the possibility to expand. T hats why most MFIs are small and stay small which this figure visualizes. About 73% of all microfinance institutions serves less than 2500 clients.

Funding / Financial Institutions

The mission for the funding institutions is to help MFIs operating more efficiently and be more effective. They provide each partner with financial products and services that are tailored to meet their needs. A goal is to ensure the partners are moving their clients out of poverty and to foster good practices for measuring the progress of the individuals movement across poverty lines. MFIs must show results, yet many do not have the tools to evaluate how well they are fulfilling their mission of reducing poverty, reaching people excluded from financial services, empowering women, or promoting community solidarity. Thats why they should also equip microfinance institutions with tools to measure their clients progress out of poverty. Built on the learnings of previous efforts in the microfinance industry they can develop the operational methods in reaching the clients. Innovative financing solutions and strategies to expand the capacity and efficiency of the MFIs provide a direct impact on the lives of the poor, and advancing the microfinance industry as it moves toward even higher standards in terms of anti-poverty impact and financial performance.

Funding Sources for Microfinance Institutions (Financing Options)

Posted by Fehmeen on April 23rd, 2010 | 2 Comments Capital availability for microfinance is hardly a problem for mature markets, as sources are ample and diverse. Despite this, many microfinance providers are unaware of the multiple sources of funds available to them. Here are some external sources for MFIs:

Saving Deposits in Microfinance

Micro-saving products, also known as retail deposits, offered by MFIs serve as a low-cost source of funding and are a common practice in Philippines, Uganda, Pakistan, Peru and Kenya. Since safekeeping the publics money is risky, most governments only allow microfinance banks to offer this product. However, some NGO MFIs with large equity pools may be allowed to accept deposits as well. Potential pitfalls here include too much or too little liquidity of cash (read other challenges for MFIs). Commercial Debt Capital in Microfinance Short-term loans (available easily) and long-term debt (available in large quantities) can be acquired from commercial banks. Additionally, international investment funds, also known as microfinance investment vehicles (MIVs), act as intermediaries between investors and MFIs, by selling securitized debt. Some famous examples are: Triodos Microfinance Fund, Oiko Credit, Blue Orchard, Microvest, Fund for South East Europe (EFSE) Even though loans from commercial source are generally priced at the market rate, which new and small MFIs may find expensive, debt capital is a popular source of funds for microfinance providers. Soft Loans and Grants in Microfinance Concessionary/soft loans (low-cost debt) or grants may be sourced by microfinance providers from socially responsible investors, which include national and regional development banks, aid agencies, international NGOs, non-profit corporations, charitable trusts, or funds held by donor and development agencies, such as: Grameen Trust, Swedish International Development Agency(Sida), USAID, United Nations Capital Development Fund (UNCDF), ADB, World Bank, Bill and Melinda Gates Foundation, Ford Foundation, IMF, ACCION, CARE. Some development agencies only interact with governments, but their funds can be accessed indirectly by MFIs. Individual Philanthropic Sources in Microfinance Non-profit investors, such as individuals interested purely in the social impact of microfinance, often lend their own money to MFIs through peer-to-peer online platform, the most famous of which are Kiva (read about this revolutionary business model here) and MicroPlace. However, raising funds through the internet is a tricky business, and you can read more about this here. Similarly, high net worth individuals who are interested in philanthropy often give away great sums of money to MFIs, in an act known as venture philanthropy. Equity Capital in Microfinance Equity capital, which acquired through the sale of ownership shares, via capital markets, is the most expensive source of capital for MFIs, but most attractive for investors because of high returns

prevalent in the microfinance sector. This source of funds is the subject of widespread criticism because some public MFIs seem to lose track of their social objectives, as Bank Compartamos did.