By most standards, microfinance is a young sector, and in many countries it can be said to still be in its infancy.   Yet its continuing spectacular growth, especially in India, should give one pause – every time promoters celebrate another multi-million-client threshold, I wonder – how many more such thresholds are left?  How do we know when we’ve arrived?

This is not a philosophical question – normally, markets send signals.  New customer demand drops.  Prices fall.  Margins decrease.  However, credit markets are funny animals – the hopeful, exuberant part of our human nature dictates that, when presented with the opportunity, we tend to overestimate our repayment capacities and borrow beyond our means.  And when we can borrow from one lender to repay another, we can stretch the cycle out even further.  The market signal gets delayed, while a bubble builds – when the signal does come, it is in the form of the bubble bursting.  Students of the US housing crisis can tell you – it is a most unpleasant signal to receive.  I vividly remember the day in January 2007, when I first learned of the unusual delinquency patterns emerging in the US subprime market – at the time this affected only a small proportion of loans within a relatively small subsector of the mortgage market, and few thought then that this presaged a crisis that would engulf the entire mortgage market, let alone the global economy.   Yet even though subprime lending had consequently all but vanished by spring of 2007, it could not prevent the worldwide tsunami from crashing down nearly two years later.  Such is the nature of bubbles.

The trouble is, determining whether we are actually in a bubble is no easy task.  A look at the US stock bubble of the late 90s and the housing bubble of ’04-07 shows a familiar pattern – the eager participants are hypnotized by the glitter of their apparent success, the “wise seers” seek ways to explain visible deviations from the norm, while the few lone voices calling for a time-out are made outcasts of society.  Yet when the bubble finally bursts, everyone adopts the common refrain:  why didn’t “they” (the government, the corporations, the media) do something – the bubble was so obvious!

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Read Complete Article at: https://www.microfinancefocus.com/2009/11/10/is-there-a-microfinance-bubble-in-south-india/

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In recent issues of this magazine, We have been an outspoken critic of what has been called:  Commercial Microfinance.  That is, an MFI operating without transparent loan or operating policies and having no BDS component, essential in an installment lending operation without a visible social development component.  Our attention has been focused upon those MFI’s that, in our opinion, have essentially abandoned the original mandate of service, in blatant pursuit of profit.   Recently articles in respected publications and other media have been critical of the Microfinance sector in general.  Although essentially anecdotal in nature, charges brought by a respected publication bear scrutiny.

As an offset to these allegations we would like to report on an exciting new development in the MFI arena.  microUP!  (see story under horizon on page 18)

We believe that our sector is about to enjoy a renaissance, a rededication and refocus (pun intended) of the now traditional model of micro lending Microfinance Focus has identified an emerging model of micro credit, tied to intensive business developments and a total focus upon tangible benefits to the poor.  Sam Daley-Harris, founder of The Micro Credit Summit and sponsor of The 2010 Micro Credit Summit to be held in Nairobi, Kenya is a major proponent of the microUP approach.  Based upon recent discussions with those closest to the issue.  Microfinance Focus perceives there are five basic principles that cover the diverse strategies employed by the three principal practitioners.  Although each one uses a different strategic approach the policies are essentially common.

The new paradigm will debut next year in Kenya and will be championed by Sam as a transformation of traditional MF into a global force for the eradication of poverty in general.  microUP is a holistic solution.  It combines lending with DBS, transparent operations and a fair honest management system that values the individual with more than lip service and places the poor in the middle of both the economic and social goals of the organization. Microfinance Focus Magazine has learned that Mr. Daley-Harris plans to launch a global effort to spread the technology and the process to all developing countries in 2010.  In discussions with leaders in the movement, we have produced an initial set of basic principles.  We will be blogging on this as  soon as the magazine is published so let me hear from you.  I can assure you that you will be hearing from me.

The Indian government is likely to introduce a revised version of the much-awaited Micro-Finance Regulation Bill, 2009 in the winter session of parliament. While the passage of it will take few months, it is bound to trigger debate and discussions.

Essentially, the passage of the Bill would result in the regulation of micro-finance organizations not being regulated by any law for the time being. Some features of the old bill, that was introduced in 2007 but lapsed with the expiry of the 14th Lok Sabha (Lower House), are likely to be retained in the new draft.  One key feature of the Bill would be to make the National Bank for Agriculture and Rural Development (NABARD) the sector regulator. But it  is to be seen whether the new draft has addressed the industry’s demand  to include even major MFIs which were excluded from the ambit of the  old bill. Some self-help groups even sought an independent body as the nodal authority and due representation to them in the regulatory body.  The provision for creation of a reserve fund and maintenance of accounts and periodical returns to be submitted by micro-finance organizations and penalties for non-compliance with regulatory requirements is more likely to be retained in the new Bill. The old Bill’s provision for registration of micro-finance  organizations collecting thrift from individual members of self-help  groups (SHGs) was severely criticized for lacking specific SHG sector  demands like better linkage with banks, interest at 4 per cent on loans  and training and assistance in marketing.

Further, the whole issue of high interest rates charged by micro-finance   institutions had been left out in the old Bill which many women organizations had opposed. They demanded a ceiling on how much interest can be charged.  It is unlikely that the new Bill would have gone through a process of re-drafting in consultation with all organizations, groups, activists,  academics and experts working in the field in such a short period. But all  members of parliament should give it a serious thought before giving their nod. The Bill aims to address the needs of the rural poor and urban slum-dwellers, whose vote bank cannot be ignored by any party  that is in power or otherwise.

The missing middle is in the conversation again … maybe because the microfinance industry is heading towards the SME segment of the market that needs financial services and is not getting services … but maybe simply because MFIs think that bigger loans will earn them more profit and improve their financial performance.

What is the missing middle? A small business can be started using the resources of family and friends. While big business can be expanded using all sorts of financing instruments … stock, bonds, bank lines of credit, leasing, etc., a small business that want to expand to be a big business is faced with a terrible problem … virtually no financial services that are serving this critical part of the economy.

This missing middle problem is not new … a commission in the United Kingdom in the 1930s, headed by Harold MacMillan, who later became the Prime Minister, identified this problem and it became known as the MacMillan Gap. The problem has never been successfully addressed … though there have been attempts. In the USA the Small Business Administration (SBA) is an initiative that has this as part of its mandate … but has only had modest impact.

The concern for the microfinance industry is that the perceived advantage of bigger loans to improve financial performance is a mirage. It needs to be recognized that loans to SMEs, while they are obviously bigger than typical microfinance loans, are also, less obviously, very different.

MFIs that migrate into the SME funding business without understanding the differences are likely to be surprised. The SME segment of the market needs a source of funding because of the missing middle, but it is not just money that is needed … it is money on the right terms, and access to services to help the SME to make the best use of the money.

The microfinance industry has had several decades to fine tune how it lends to micro-entrepreneurs and gets repaid with almost no losses. Close contact between a loan officer and the client has been a key to the success, together with peer pressure from groups associated with a group member and their loan. The risk of default in this business model is low based on the record of repayment over the past many years.

This approach for microcredit but is not going to be effective for SME lending. SME lending needs to be on terms that suit. Typically this will be financing for a much longer period, usually with some period of grace. The risk is higher … the reward potential is higher … and the time period is very much longer. In other words … this is a totally different sort of financing.

Furthermore, this is not merely “bigger microenterprise” … rather it is a big step from very informal business to the start of business that is formal and organized. There are needs for the SME owner to learn new skills as the access to financing gives opportunities for growth. Growth may be moving the small enterprise from staff comprised of just family to non-family employees and all the challenges of supervising staff. Maybe the business is going to be more complex … with more customers, more suppliers, more facilities and equipment, more working capital and more problems. Maybe it is time for the planning to go from informal to formal … with some budgets and planning.

Because lending to SMEs to solve the problem of the missing middle is so very different from lending to micro-enterprise in the microcredit mode … the microfinance model cannot be the answer.

What is the answer?

What an SME owner might want and what might be possible are usually not at all close. People with money for financing did not get into that position by being nice but by doing business in ways that created wealth and produced the money.

Someone providing financing wants to control the risk … and that usually means controlling the business. This is a major change for a small business owner, and one that few are able to handle successfully. A small business owner who does not understand this is heading into trouble.

It is a cliché … but the best time to get financing is when you don’t need it. Then the negotiation about risk sharing and ownership sharing can be done without excessive urgency ahead of a crisis deadline.

But the small business owner is really in an impossible position. The person with the financing has experience and the small business owner does not. In this situation the small business owner is unlikely to win … and usually does not. There is a role here for a reputable consultancy or business incubation service. The role is (1) to serve as a mediator and organizer of financing so that there is balance between the interests of the business owner and the source of finance; and, (2) to coach the business owner through the essential changes that are needed for successful growth.

This seems to be a fairly obvious idea … but it is not at all easy to implement. The end to end value chain is very positive. Small business plus business incubation plus financing resulting in a successful growing business is a good formula.

But this hangs up at the beginning of the process and in the steps along the way. The small business plus the business incubation has value, but itself needs funding … and if this is inadequately funded, then the financing source is again in the driver’s seat and the outcome of any negotiation will favor the financing.

There are signs that there is investment being mobilized to finance the SME sector … but the focus has been on the larger entities in the sector with track record. The financing is perhaps in the $500,000 size rather than $50,000 or $5,000. Only a small bit of the missing middle or gap is being addressed.

It is more than 70 years since the MacMillan Gap was identified … it remains a difficult problem.

Unfortunately for most small businesses in the developing world, the levels of venture capital that are available exceed what they can either qualify to receive, or effectively use if it were provided to them; in a growing business, oftentimes too much success (or, in this case, venture capital) can be as deadly as too little success.

This, then, is the basis for both this month’s column as well as the theme for the magazine.  That some small businesses have the potential to grow is inevitable when compared to the larger number of small businesses that are funded by the typical MFI.  That these businesses will eventually require more capital than the MFI’s loan limits will support is also inescapable.  As such, two problems must be resolved by the MFI and the growing business:  (1) Will the MFI necessarily lose a valuable client because it cannot change its business model in a way that acknowledges the success of its best customers?; and, (2) Must a growing business choose to limits its potential in order to be able to live within the funding that its MFI is willing to provide?

Since very, very few small businesses have the potential, in terms of management capability and revenue potential, to qualify for traditional venture capital investments that may start at US$50,000, or higher, in their country, this is a significant problem.  The businesses cannot acquire the capital they need to support their growth, and the traditional MFI’s have not shown a willingness to support these types of customers.  In the domain of Marketing, this presents a set of opportunities.

Since marketing is often tasked with creating new options for the organization it serves, I would like to discuss two classic strategies from the arena of Product Marketing.  The first is the concept of the Product Line Extension, and the second is the concept of the Product Line Expansion.  In a product line extension, an organization will expand its offering by the introduction of a product (or service) that provides a new functionality or capability while remaining consistent with the existing products that are offered.  The organization can forecast the degree of success of this new product among its existing customers based upon their business requirements, the willingness to buy the existing products, and the capabilities the new product offers them.  In the context of the MFI, this might be a line of credit, in the form of a revolving loan, that would be greater than the traditional loans offered by the institution, and that can be accessed as needed by the growing business rather than being taken all at once.

The benefit of this type of a product is that the MFI will still view it as a loan, although not one that has a regular, defined payment each week.  The benefit to customer is that the business need not take on the burden (or risk) of borrowing more capital than it needs at given point of time, while having the flexibility of borrowing against a larger loan value than previously offered, as needed.  By extending its offering with this new type of loan product, the MFI retains consistency with its existing loan products, the customer understands the nature of this new type of loan, and the potential size and profitability of the market for this new type of loan can be forecasted by the MFI.

An alternative approach would be to create a product line expansion through the introduction of a new type of product that expands the potential class of customers who may be served by the MFI, that is not required to be consistent with the existing products offered, and yet does not commit the MFI to the cost and risk of looking outside of its existing market.  Such a financial product might be a longer term loan, perhaps one with a period of two years, with the payment deferred until the end (a balloon payment of the principal and interest), and at a larger amount than the traditional loan that is repaid weekly.

This type of loan product would differ from the existing loan products in that there would not be a consistent, regular payment, and would be a hybrid between the classical loan (in that it would still have to be repaid) while offering the value of an investment (without the MFI incurring the risk of ownership in the customer’s business).  Such a product would create a new class of customers for the MFI, at a reasonable risk and cost, while allowing it to stay within the industry that it understands.

The two examples above are fairly basic solutions to a problem that exists, that are easily implemented, and would be understood by both the MFI and the customer.  Whether MFIs implement these two solutions, or choose to create others, they must find a way to continue to serve their best customers as they grow (and prosper), or permanently lose the most profitable customers in whom they have invested time and effort.  In order to solve this problem, the marketing department, which has a primary task of creating opportunities to support the growth of the MFI through the identification of new classes of customers and creating product ideas that will satisfy them, must take the lead, or be relegated to a secondary role as others within the MFI demonstrate the type creativity and innovation that should be Marketing’s purview.

I look forward to reading your thoughts and ideas, on our blog, as to how you, the reader, might create a product for your, or any, MFI that would allow them to continue to serve their best customers as they grow their businesses.    ***************

The Missing Middle describes to the lack of funding for small to medium sized enterprise, (SME) who have progressed to the limits of MFI lending.   (around 1,500 USD).  It is the absence of funding options for small growing businesses at the bottom of the financial services pyramid.  Traditional venture capital firms are interested in much larger investment of ten to twenty million dollars and have largely ignored this potential market.

The missing middle as defined by ANDE (Aspen Network of Developmental Entrepreneurs) is between 50,000 and 2 Million USD.  ANDE was formed by the Aspen Institute to provide a venue and platform for NGO’s and others who wish to provide investment and knowledge capital to both SME’s and SGB’s. The small business is the very heart of any healthy economy.  Most new jobs come from the small business sector.  If the small growing business, (SBG) is the incubator of the merchant class, it is also the nursery of a necessary and vital commercial sector.  Where the micro enterprise provides sustenance and security to the family, the SGB provides opportunity for jobs and lays the foundation for prosperity and community economic development. As the Microfinance sector matures and seeks larger and potentially more lucrative financial markets, the SGB is seen as a possible area of expansion.  Already, some socially responsible investors like Willie Foot’s Root Capital are moving into the Missing Middle with significant success.  After all, the greatest potential for growth is always at the bottom of any market.

It is important to note however that the traditional business model of the MFI may not be appropriate for the financial needs of the SGB.  Where weekly installment lending may be adequate for the small family run sustenance business, a growing enterprise has capital and cash flow needs that the MFI model does not meet.  The business of providing financial services to the SGB is a different business model and will require a different financing strategy to be successful.  What new skills and business methods will be required?

A key activity will be in supporting SGB management introducing technology to enable growth and monitor performance of the SGB.  Key skills currently not in the SME repertoire like intensive BDS (business development services) and value chain management will be needed.  The MFI loan officers will need to be retrained to reflect the more sophisticated needs of the SGB.

Finally, in some places MFI profitability has actually suppressed SME investment, investors preferring the relatively safe and profitable lending to the larger but somewhat more risky venture investments.  Still, as economies develop the need for investment grows and opportunity abounds, great opportunity exists at the bottom of the market.  We believe this is just the beginning of a new era in Microfinance and a new era in global economic development.

What is the difference between sales and marketing?   If you are in sales, can you be a marketing rep?  Well, not to be too equivocal: yes and no.   A definition of Marketing:  It is the management and administration of the four “P’s” (Price, Place, Product, & Promotion).  Marketing provides the answers to these four questions:  (1) How much do we sell it for? (2) Where and to whom do we sell it?  (3) What is it that we sell? and, (4) How do we get people to know about it?

In a misplaced effort to raise the perception of marketing as a higher function, management (and many business school professors) has often confused the two.  Marketing is a support function, whereas Sales has “line” responsibilities.  Sales is responsible for the top line on the balance sheet—Revenue.

Sales is different from marketing.  It is informed by Marketing.  It applies the output of Marketing.   But, it is NOT Marketing.  The function of the Sales department is to generate revenue, not create awareness.  If your principal job involves selling loans to borrowers, then you are a financial services sales rep.  If you sell loans, take applications, disburse funds and manage the repayment of these loans, you may also be a loan officer, but you are definitely a salesman.

Microfinance Institutions (MFI’s) have a need to constantly increase the size of their loan portfolios.  This results in larger loan and larger borrower populations with increasing portfolios.  How can this be done at a reasonable cost and while maintaining control over both Marketing and Sales?  First, establish a Marketing department and a Sales Department, and do not confuse the two.  Let Marketing develop financial products, position the sales people, design the promotional campaigns, and create the sales literature.  Separate Finance from Marketing—you need different people in each.  Marketing personnel can use the financial expertise of your finance department, but you need Marketing experts to create products, not financial experts.

Now, what does this have to do with technology?  Remember, technology is one of many tools you may apply to do your job.  There are sales tools and marketing tools, and they are not the same.  Sales tools are pro-active, and mostly used to organize, present, manage and control the sale to the customer.  Marketing tools are analytical, organizational, communicational, and presentational.

By the way, do not try to make your sales people into loan officers, either!  Give them a set of criteria, and let the Branch manager make critical decisions.  These people are your sales force.  Don’t try to make them do too many jobs.  Use technology, like MIFOS and customer relationship management (CRM) tools like SugarCRM, to support their performance and simplify the record keeping process.  Use technology to keep down headcount and empower the existing staff.  Remember, above all else, do not confuse Sales and Marketing.  And remember, I’m watching.

The 18^th Century was considered the beginning of the Industrial Revolution, in which new forms of mechanical devices and machines were introduced to improve productivity, lower cost, and allow for the manufacture of products that otherwise were not practical to produce.  In the 20^th Century, we witnessed the beginning of the Information Revolution, the revolution which, more than any other, has eliminated considerations of strength, gender or wealth of the individuals who are the technology developers.  With the advent of the information revolution, the key determinant of success has become the intelligence with which it can be developed and exploited, not the physical strength or gender of the person creating it.

As individuals, companies, and countries, we are still finding new ways to exploit the various IT technologies developed (or promised) only a few years ago that are finally becoming available.   In this age of what is increasingly ubiquitous information technologies, ranging from smart cellular phones to (freely available) open source software and broadband communications backbones, the MFI industry, like every other industry, is faced with the dilemma of which technology to implement and at what cost.  Unlike the industrial revolution, the pace at which the technologies spawned by the information revolution have become affordable, in some cases to the point of becoming commodities, is unmatched in history.  The nature of the information technologies (IT) that are now widely available have significantly diminished the gap between what large companies can afford and what small or non-profit companies are able to acquire.  With the affordable nature of technology comes the inevitable issue of how to evaluate, select, implement, and manage these technology options.

This month’s issue is primarily focused on the use of information technology (IT) in the MFI.  Jerry Peloquin, who normally writes this editorial, often refers to IT as the “nervous system of the business” – creating an analogy of the business’s computer software, hardware and communications network with the human body’s nervous system, through which all physical sensations from and commands to the body’s muscles and organs flow.  This is a useful way to think of IT in terms of its value to the modern business, in that the business is no longer able to fully function without an effective IT “system,” as well as the degree to which IT has penetrated every function within a modern business.  Like the human nervous system, the average business person no longer thinks of the IT system as something unique or special… it is just something you expect to have as part of a functioning  organization.

The problem with letting the value of IT slide into the background, where it is viewed as just another business function, is that IT has typically lost its unique distinction, and, therefore, a sense of its contribution to the business.  With the change in status where IT is now viewed as a common function, rather than a unique capability, IT is no longer challenged in terms of its existence in the organization.  IT is, though, often misunderstood as to its value, or worth, to the organization.  While it would be impossible to highlight every technology option that an MFI could choose to implement, in this, our first IT-focused issue, we have decided to present editorials, articles, and reviews of a few of the available software products that we believe offer a greater benefit through their use than would be available without them.  Essentially, in this first, focused issue, we have tried remind our readers of the value and worth of IT’s contribution to the MFI.

The microfinance sector has become more vibrant and dynamic as never before. True, it took a leap of imagination for Mohammad Yunus  to create a bank that lends to the poor without any collateral or credit histories. His Grameen model of microfinance has had a transformatory impact not only on the lives of millions of poor and unbanked entrepreneurs but also on the way self-help groups world over raise money for their activities. Now that the economic meltdown has ushered in a new ‘capital shift’ from the traditional targets of investment by private equity funds and venture capitalists, the microfinance sector can take the opportunity to reach its goal of financial inclusion of all, sooner than expected. But they should tread ahead cautiously not to aggravate the levels of returns on their investments but to reach out the new groups, preferably those who were left untouched in far off regions around the globe.
Not lagging behind, we at Microfinance Focus have decided to match the expectations of the sector with an online news feed through our Global Centre for Microfinance News, which we are sure would help bridge the knowledge gap. Our monthly magazine, as ever, would cater the practitioners and advocates of microfinance with in-depth analyses of recent trends that the industry is witnessing both at local and global levels.
Further, it is our sincere hope to bring in even the small and so-called ‘insignificant’ MFIs into the mainstream as our media partners and give them the much needed platform to get exposure to the world of funding and strengthen their motivation. We are sure every MFI, whether small or big, has a lesson to tell the world. We wish to be their eyes and ears to the rest of the world.

Back in India, where the move to pass the Bill on Microfinance Organizations is still pending, the government cannot wait for long but expedite its passage through parliament at the earliest. The need of the hour is not only to help those who want to help themselves but also protect them from the rush of greedy moneylenders masquerading in the guise of microfinance outfits. A legislation now would go a long way to refine the process of microfinance in India.

In the early 1990’s, Robert Kaplan, a PhD-level professor of accounting at Harvard University, wrote a series of papers on how business should (could) consider the value of IT.  His principal position was that traditional accounting standards had no valid methodology for quantifying the value of IT in terms of its benefits to the organization (beyond the level of saying that an administrative assistant could type more letters with a computer than a typewriter).

This limitation of not being able to quantify the value of IT, from a classical accounting perspective, coupled with the current diminished status of IT to the rank of “just another department” within the MFI, has the potential to short-change the MFI when  it is creating its annual operating budget.  IF you cannot determine the value of IT, how do you determine an appropriate level of funding for IT that will allow it to contribute to the operational capability of the MFI?  IF you cannot determine the value of its contributions, how do you determine the worth of its accomplishments?

Unless the IT function is buying a specific piece of software, either operational or financial, to satisfy the requirements of the local government the MFI operates under, or to satisfy the requirements of a donor organization, few MFI managers adequately determine the worth of an IT investment.  Since the average IT professional has not been trained in how to construct a financially-valid business case to support the implementation of new technology, or to provide a system of metrics that will allow others to determine the value of IT’s contributions to the organization, the average manager in an MFI will usually just try to make an informed guess as to the worth of the IT department’s annual budget request.

With the ever expanding role of IT in the MFI, and the creation of services that are not possible without the use of technology.