Microfinance Focus, October 26, 2012: With European Microfinance Week fast approaching, we at Microfinance Focus thought it appropriate to interview influential members of the European Microfinance Platform (e-MFP) and the microfinance community at large to get their perspective on current events. In this interview, David Roodman, Senior Fellow at the Center for Global Development in Washington, DC, discusses his thoughts on building healthy financial sectors, regulation, and the future potential of electronic payments. 

Microfinance Focus: David, when you think about microfinance these days, what’s on your mind? 

David Roodman: In my book (Due Diligence: an Impertinent Inquiry into Microfinance), I have a chapter on Development as Industry Building. However, in writing it, I think I blurred the distinction between building an industry and building institutions. The two are quite different. Whereas institutions can be built independently, a healthy financial industry depends on all the parts being in place. It’s like an ecosystem, where the role of every entity is in balance. That’s why I recently blogged that “a banking system is more than a bunch of banks.” Historically, the microfinance sector has focused on building institutions. It’s much easier to just start making loans rather than waiting to first develop the regulatory infrastructure. And there’s nothing wrong with that – by building MFIs, actors can generate momentum over time, with regulators becoming increasingly involved as the sector grows. The trouble is when MFIs grow so fast that a large imbalance in the system arises. This is what we’ve witnessed in the past few years in some countries. 

There have been microcredit overshoots, but also gradual improvement in the regulatory regime. And it’s part of a normal, if unfortunate, cycle – this is how financial industry got build over the past 150 years in today’s rich countries. It’s a human tendency to have to learn lessons the hard way (and forget them, and then have to relearn them once again!). 

MFF: Have we now relearned this lesson that there needs to be balance within the system? 

DR: I think so. If you look at recent funding trends, it’s clear that flows to microfinance are slowing. This year’s MicroRate MIV survey cites a “new normal” growth rate in the low teens. The survey by Symbiotics tells the same story. This is healthy. Rapid capital flows have been a major component behind the problems of the past few years. That said, what matters isn’t the global rate of growth, but growth in any given market. Practically speaking, investors might be more attuned to this risk now, so the risk of overheating is lower. But the potential is still there. 

MFF: So how do we deal with this issue? How do we keep markets from overheating? 

DR: I’ve argued before for having some sort of an industry body to monitor local markets and risk. Of course this isn’t foolproof – any oversight body could get it wrong and actually cause overheating by creating a false sense of security. Nevertheless, it’s important to have a better mechanism for communicating warnings to the industry in a way that would make them more difficult to ignore. The question isn’t whether such a body would be perfect, but whether it would be an improvement. The fact that there isn’t a reliable mechanism for communicating such warnings is a concern. Multiple individuals and organizations may be sounding warnings and that seeps into the general discussion, but that doesn’t mean that the message gets sufficiently internalized by investors. Part of the issue is that different investors have different incentives. Private, dedicated microfinance investment vehicles may be more prudent because their institutional survival can depend on avoiding market meltdowns. But this may not be as true for individuals working in public investment institutions, the DFIs, who have strong incentives to meet lending targets, and often hop to new jobs within the agencies before any of those proverbial chickens come home to roost. So how do you get those warnings out there? Perhaps if someone were to start coming out with an annual report of hot-spots to watch, that might help shape the community of thought. And informality of the system might prevent over-reliance on it—people taking its judgments as gospel. 

MFF: You have written a lot about the need to focus more on deposits. What’s on your mind these days when you think about deposits? 

DR: Expanding savings requires sound operations and regulation. I am recalling the CGAP Consensus Guidelines for Regulation and Supervision. But in many cases a government might not have the capacity to supervise all deposit-taking institutions. In cases where government doesn’t supervise institutions, they must at least disclose the absence of that supervision. Clients should know that they are on their own; that there is no deposit insurance to fall back on, no guardian angel monitoring the asset side of the balance sheet. An example of this might be cooperatives, which operate under a legal framework, but can’t all be closely supervised. If we look at Bangladesh, we see the leading institutions – Grameen, BRAC, ASA – which have been collecting savings for years, but have been doing it in a kind of regulatory grey area. So far there have been no problems, but there’s no infrastructure in place to deal with those problems if they were to arise. Recently the Microfinance Regulatory Authority there has been gaining strength and has proposed a deposit insurance scheme for these institutions, which would cover deposits up to 3500 taka ($42). That might help to protect clients from potential risks down the road. And while the balance limit is low, one can imagine it rising over time once the system is set up. Doing savings carries its own risks – fraud or mismanagement or excessive risk-taking can cause institutions to lose client deposits. Even well-run institutions could be undermined if there is a run on the bank triggered by events outside their control. Having the regulatory infrastructure in place to avoid such situations is critical from the perspective of building durable industries. 

MFF: What interesting new developments do you see out there that may signal significant change for the sector? 

DR: Well, there was the recent launch of the Better Than Cash Alliance, backed by the Gates Foundation, USAID, Citi, Visa, and others. It focuses on promoting electronic payments for financial transactions. This makes some sense; microfinance is an evolutionary process, and has always been about working at the frontier of what’s possible. Hence innovations of using groups, lending to women, and other changes that made making small loans a realistic business proposition by cutting costs or shifting them onto clients. So the question is, does mobile money – POS devices, cards and so forth –shift the frontier? Well, it’s unlikely to lift people out of poverty, but it probably does provide opportunities for providing better financial services. So I do think it is right for donors to be pushing hard against the technological frontier. It promises to cut costs and improve the flexibility and diversity of service offerings. I do have a concern though. Microfinance has succeeded largely by working from the bottom-up, conducting small experiments in various places, finding out what works, then scaling that up. But this feels more like a top-down initiative, not a bottom-up one. Sure, it builds on the example of M-PESA and a handful of others, but do we know that this is the right approach? The best approach? 

MFF: So how do you see such services changing microfinance? So far, even M-PESA doesn’t seem to have moved much past being a platform for facilitating payments. 

DR: Look, technology is a great leveler. Poor people today have much better lives in many respects than rich people 200 years ago. They can call someone halfway around the world – and not just in theory, but at prices they can actually afford. They can get vaccinated against diseases that would once strike down even the wealthiest. So maybe the poor can also have financial services better than the rich did 200 years ago. Mobile money is fundamentally new. It’s more common to transfer money by phone in Kenya that in the US. But why hasn’t the microfinance industry adopted this technology yet (roughly speaking)? Maybe it’s part of where the industry is in its lifecycle. While there’s no question that there was great creativity in microfinance in the 70s and 80s, perhaps that leveled off in the period that followed, as the industry took the lessons it learned during that time and focused on scaling them up. Will the microfinance industry as usually conceived be fundamentally changed by the new electronic payments technology? To quote Niels Bohr, predictions are difficult, especially about the future… But if an MFI in, say, Mexico were to shift its operations entirely to a digital platform, and then leverage that shift into fundamentally new service offerings, that would be revolutionary. So far that hasn’t happened to my knowledge. But I think it would be useful for donors and social investors to be on the lookout for institutions experimenting with such changes, and try to support them via grants or seed capital. I assume some already are. That builds on exactly the kind of bottom-up innovation that created today’s microfinance industry.

By A.M. Godbole,
Microfinance Focus, October 22, 2012: In its 21st September 2012 draft on a standard product for Rural and Social Sector the Insurance Regulatory and Development Authority (IRDA) says “IRDA shall prescribe annual target so as to cover entire BPL population in the next 5 years.” This path-breaking goal will require innovations in product design and product delivery.

Product Design and Product Delivery:

First, we should remember that life insurance is useful for the dependants of an insured life. So, if there are no dependants then there ought to be no life insurance.

Second, the dependants of an insured life should experience a reduction in pain when the insured life is lost. The dependant never ought to experience even the slightest joy when the insured person expires. This means that the life insurance cover ought not to be superior to the financial support that the insured life may provide when alive. Furthermore, the life insurance shall necessarily not be for whole life as the insured life person will be in a position to support the dependant through his income stream only during his working career. This is important for another reason: the dependants should never have a financial incentive/motive to cause the death of the insured life.

Third, the life insurance cover may be realized in lump-sum or annuity or a mix of the two depending upon the need of the dependants. This is because the insured life may have the financial responsibility of one or both types. For example: a daughter’s wedding expenses would require a lump-sum realization. Many other expenses would require an annuity.

Fourth, the life insurance cover cannot be defined upfront. Defining the life insurance cover upfront is laden with risks for the customer as the real value may be diminished substantially by inflation, and also for the life insurance company as the inflation indexed bond market in India is virtually non-existent. The life insurance cover, ought not to be constant during the term of the cover as the financial responsibility of the insured life is not constant during the term of the life insurance cover. The default plan: the term for which the life is insured, assured amount at every year of the term, and the break-up between the lump sum amount and annuity in the case of the death of the insured life; shall be given by the insurance company to the regulator.

Fifth, for the poor customers it would be best if the government pays the premium collectively to the insurance company. This should be done for three reasons: in the case of poor people the cost of acquisition plus ongoing administration costs is substantial and at times even greater than the net premium itself. The universal applicability of the insurance among the poor shall reduce the cost of customer acquisition substantially—the government has to provide the Aadhar numbers of all poor people and the poor people have to update the insurance company with dependency relationships by specifying Aadhar numbers; the poor will not be able to afford insurance.

Sixth, the death certificate needs to mention the Aadhar number of the insured life and dependant life as the case may be. This is to ensure that impersonators do not make claims and that the cover is adequately distributed among the living dependants only.
Seventh, the life insurance cover will have a permanent disability rider. A disability certificate with the Aadhar number shall be required for claiming the insurance cover.

Let us not underestimate the magnitude of these challenges. The complexity is often in the details: how will the insurance cover be computed for each insured life; how will the term of the life cover be determined; how will the differences in the life insurance covers be explained to the poor; how will the disability be assessed in a fair manner; how will it be ensured that poor are not excluded… While we may start with a good product design we will need to improve the product design and delivery with a half yearly (or more frequent) review. In most cases the new product design will have to be applied retrospectively–by tweaking the default plan communicated for each insured life to the regulator— with the permission of the regulator. Later, the poor ought to be allowed to select among a variety of simple default options.

About the recent IRDA draft regulations related to a “standard product”:

With Socratic wisdom we collectively ought to accept that we do not know the perfect product design and altogether drop the idea of a “standard product” (a combination of a minimum set of product features: involving both life insurance and general insurance together) as described by the IRDA in the same draft because although it may be well-intentioned: a universal life insurance product for the poor based on Aadhar numbers may not add to the operational costs of other products for the same insured life, thereby negating the need for a single standard product.

Furthermore, in their paper “A business case for microinsurance: An analysis of the profitability of microinsurance for five insurance companies” Janice Angove and Nashelo Tande say “Microinsurance tends to function best when claims are straightforward to verify and not easily subject to fraud (e.g. life insurance) or when a group is involved in claims management (e.g. farming co-operative). “ Let different product designs evolve.

IRDA’s distinction between government sponsored insurance for the poor (i.e. insurance in which the premium is paid by the government) and microinsurance does not serve customer interests in anyway.

Measuring Product Delivery:

The product design has to go hand-in-hand with innovative and efficient product delivery. The product delivery needs to be measured and accompanied with rewards for exceeding targets and penalties for falling short of targets. Here, the IRDA’s measurement of the delivery by a “unit credit” (suggested in the same draft regulations) could be enhanced to define a tradable market for microinsurance credits similar to carbon credit markets (“Microinsurance Credits: A means of moderating insurer compulsion”; A.M. Godbole & Michael J. McCord; The Journal of Insurance & Risk Management: Pravartak January 2009).

With the right approach we can experiment and iteratively improve the product design. This combined with a system of incentives and penalties associated with microinsurance targets, is our best hope for achieving universal life insurance coverage.

****
About the Author:A.M. Godbole is working as business analyst with a financial software company in Bangalore. These are his personal views. He may be contacted at godboleaniruddha@yahoo.com .

Microfinance Focus, October 22, 2012: With European Microfinance Week fast approaching, we at Microfinance Focus thought it appropriate to interview influential members of the European Microfinance Platform (e-MFP) and get their perspective on current events. In this interview, Dr. Hans Dieter Seibel discusses the major microfinance news of today, in the context of the past. Dr. Seibel on the board of directors at e-MFP, as well as an expert in microfinance history.

In a 2005 paper titled, “Does History Matter? The Old and the New World of Microfinance in Europe and Asia,” Seibel explains through historical research, perhaps we can learn from the mistakes of the past in order to help impoverished communities in the present. Seibel highlights the progress of the savings movement in Germany, from the first cooperative founded in 1850 to the modern age, where cooperative banks and similar institutions now comprise over half of all banking assets in Germany (1997 data).

Seibel reminds us that microfinance is not a recent development, nor a temporary solution for developing countries. In recognition of European Microfinance Week, we discussed the relationship between European and Indian microfinance histories. Seibel explains how the future of Indian microfinance could benefit from a lesson in history, especially when it comes to effective supervision and regulation.

Microfinance Focus: What are some key lessons from Europe and Asia’s past concerning the regulation of microfinance?

Dr. Hans Dieter Seibel: “Before the German Reich, the German empire, existed there was the Prussian State. The political system of the area before that was absolutism, there were 38 separate, independent states. The first laws governing financial institutions that arose were those of the Prussian State, because that was the first major state. The first Prussian savings banks regulation was in 1838, and the first Prussian cooperative law was in 1867.

“Without this legal framework, this movement could not have spread. And this is something that has not been recognized in developing countries…The credit NGOs hated regulation and supervision. They just wanted to do their own thing.

“As a result of the crisis of the last few years, this is becoming an issue for organizations, but above all to governments. Governments realize, and central banks now realize that they have to regulate. Something they shied away from in the past.

“It is not only the regulation; it is also the associations and networks behind the movement that brought about the legislation [in Prussia]. The legislation in Germany was not imposed by the state on an unwilling sector. Quite the contrary, it was the savings banking sector, the cooperative sector, which requested regulations, because they felt as institutions they needed the legal protection, and their members also needed the legal protection.

“These are certainly lessons, the importance of legislation, of regulation and supervision, the importance of networks and associations, that can be clearly distilled from history.”

MFF: The Indian microfinance industry is facing strict regulations mostly due to the lending-related suicides in Andhra Pradesh, however many argue that the immense debt that led to these suicides could be linked primarily to moneylenders. What historically causes an increase in client indebtedness? What can prevent this in the future?

HDS: “The issue of moneylending in India is more than 2000 years old. I don’t think that the moneylenders are the problem…the real issue in my opinion is that the poor have no opportunities to deposit their savings.

“If you can’t deposit your savings anywhere, if you don’t have anything to fall back to, then [with] every small crisis, every small financial need… you have to run to someone to lend you money. This can be friends, this can be neighbors and if their funds are exhausted, then there is the moneylender.

“There are going to be friendly moneylenders, and there will be unfriendly moneylenders that charge very high interest rates, some may not even be interested in you paying back a loan.

“Over-indebetedness has something to do with the fact that people have different financial needs. I did a small study in Andrha Pradesh last year, amongst elder group members incidentally, and each one of them had loans from between four and six different creditors. Most of them were not moneylenders.

“In my view it has something basically to do with the fact that you cannot deposit voluntary savings. The self-help groups, the MFIs, they all have compulsory savings programs, but compulsory savings, they are something like a collateral substitute. You cannot withdraw them in the case of need.
“What really made the savings banking movement great, the cooperative banking movement great, in Germany and other countries in Europe and also India between 1904 and the mid-thirties was the opportunity to deposit personal savings.

“This is an issue that is rediscovered every 20 to 30 years. The microcredit movement swept it away. Now, the microcredit movement got into its problems and now we are back to discussing serious savings issues.”

MFF: Can savings be worked into the current microfinance structure, or does the industry need to transition to a new model?
HDS: “Microcredit institutions that do not give members the opportunity to deposit or/and withdraw savings, well they are just a structural disaster. And that is the genuine reason why so many things are going wrong.

“These organizations that do not mobilize savings, where to they get the money to lend to their clients? They get it from investors, and then you get into this whole commercial thing…where ultimately the investors want to maximize their profit, and that means you have to expand too hard, too fast. You have to lend to anybody to make a fast buck.

“It’s just like what happened in America in 2008 with Lehman Brothers, on a very different scale, but it’s the same sort of story — grabbing, grabbing, grabbing. There is only one solution to that in my view…give people the opportunity to save in a safe place, and to which they have access.

“Microcredit is not a solution to finance. It’s a supplementary solution, yes, but the basics for the individual and for the institution has to be savings mobilization, savings depositing.”

MFF: What is the historical relationship between microfinance in Europe and India?

HDS: “Starting in the 17th and 18th century, there was mass poverty in [British Colonial] India. Moneylenders expropriated from borrowers, charging very high interest rates and structuring the loan in such a way that borrowers could not repay. They grew into a new social class, not just moneylenders, but also landowners who derived land ownership from expropriation.”

“The British Colonial system made all kinds of efforts to remedy this with state subsidies, and all of them didn’t work. Now comes the year 1894, and someone by the name of Sir Nicholson. He heard of developments of Germany. He wrote a report as to what to do about the situation of poverty alleviation in India and the report was summed up in two words, ‘Find Raiffeisen.’

“Raiffeisen is the credit cooperative movement in Germany for rural areas. The result of this was, to answer your question very precisely, in 1904 the first cooperative law was passed in India and in Burma…it was modeled after the Raiffeisen system. In 1904 the law came out…within about 20 or 25 years, about 50,000 credit cooperatives were operating in rural India. That was the result of that law and the experience in Germany.”

MFF: Is there historical evidence that this cooperative law was successful?

HDS: “There were no impact studies, but the reports that we have say ‘there were immense benefits to the farmers.’
“The Registrar in the 1920s, [C.F.] Strickland studied the situation. He gave us a report on where the resources [for cooperatives] came from, and he said 60% of the resources were mobilized by the cooperatives themselves, 40% were commercial credit. So essentially, they were self-financed. No donors, no government. Until the mid-1930s, the majority of resources are mobilized by members of the credit cooperatives, plus access to commercial credit.

“1935, The Reserve Bank of India became operational. And that central bank said, “Oh this cooperative movement is a great movement, we have to help them get aid.” They refinanced the movement, and put in their own money. After Indian Independence the government declared a state partnership for the cooperative movement…governments in the various states provided credit and used the cooperatives as credit channels. [The government] installed its own staff, sometimes you could even say ‘cronies’ into cooperatives and cooperative banks.

“And then the government took over the cooperative movement…used and abused it for political gain. And that is the story that led to current figures…2006, 51% of credit cooperatives [in India] are insolvent. This is a story which repeats itself time and again, the government has a tendency of abusing substructures. The fundamental distinction if you compare different movements in different countries, is between those where the government provides a conducive framework and those situations where the government exploits these for its own benefit.

“It’s two things, regulation and government support. Regulation is something that comes out of a more or less rational process, and then there are the politicians and the politicians are greedy actually…Before elections [in India] the subsidies go up, and the interest rates subsidies appear, and the loan waivers appear or the promise of waivers, and it’s highly disruptive.”

Microfinance Focus, October 10, 2012: The European Microfinance Platform (e-MFP) recently released a tentative schedule for 2012′s European Microfinance Week, to be held on the 14-16th of November in Luxemborg. This year’s program includes speakers and sessions that loosely revolve around the conference’s theme, ‘combining strengths – delivering results.’

The first day of the conference will be entirely dedicated to Action Groups. According to the e-MFP website, “e-MFP Action Groups are the result of productive synergies between European microfinance actors, enabling constructive dialogue and cooperation between e-MFP members.”

Action groups will meet to provide a focal point for a range of specialist interests, as well improve and multiply coordinated activities between members. Some of the groups meeting on the 14th include, CGAP, ACP-EU Microfinance Program and FEMIP.

The following day of European Microfinance Week will begin with opening remarks titled ” Microfinance – delivering results.” The speakers at this opening plenary include Bob Annibale of Citi, Sanjay Sinha from M-Cril and Jeniffer Riria from Kenya Women Finance Trust.

Following the opening remarks, members will break into focus groups. Groups will discuss central issues such as regulation, innovation in microfinance, and measuring social impact. These groups will meet again the morning of the following day.

Members can then choose to attend one of six sessions moderated by industry professionals. Highlights of the first series of sessions include “Prioritizing and Sequencing Microfinance Regulation” with Thomas Foerch and Florian Henrich of GIZ, based in Germany as well as “Cooperatives in the Financial Sector” moderated by Hans Dieter Seibel of e-MFP/DGRV and Paul Armbruster of DGRV, among others.

The 4th European Microfinance Award will be presented on the evening of the 15th to one of three finalists in order to highlight efforts of individuals and organizations that represent major breakthroughs in promoting food security. The European Microfinance Award is jointly organized by the Luxembourg Ministry of Foreign Affairs, the Luxembourg Round Table on Microfinance and e-MFP.

The second day of sessions (officially, the third day of the conference) will cover a wide variety of current issues in Microfinance. For example on the morning of the 16th, Kate McKee of CGAP and Michael Chapman of OECD will moderate a session on consumer protection and regulation for low access environments, while sessions on food security, post-emergency microfinance, and innovation as a means for providing financial services to women will be held simultaneously.

There will be more sessions held in the afternoon, including a Luxembourg roundtable on Microfinance. European Microfinance Week attendees will also discuss such issues as financial transparency, Islamic microfinance and microfinance initiatives within the EU during this series. A second session on food security, titled “Microfinance Investing in food security: challenges and opportunities,” organized by the Association of the Luxembourg Fund Industry (ALFI) will be conducted on the 16th.

Food security as well as cooperatives and the importance of savings promise to be areas of repeated discussion during the conference. However, since sessions provide an open floor for members to share ideas, it is difficult to predict exactly what issues will be discussed and highlighted.

The closing plenary will include speakers from the Center for Global Development and MIX Market, as well as Marc Bichler, Chairman e-MFP/UNCDF.

To register for European Microfinance Week 2012, click here.