By Peter van Dijk,
Microfinance Focus June 2011:Microfinance (MF) can indeed be a powerful tool to fight poverty; I am convinced of that, it is common sense. And it can do that in two ways. Microfinance can provide a tool (defined as an institution, a product or service) to so far unbanked people to safeguard the little money they have and assist them in better planning and undertaking expenses, transfers and investments. And Microfinance can also be a social service providing loans that are targeted to specific groups of people: the poorest, small farmers, women, youth, handicapped people, elderly, unemployed, people living in remote areas etc. In the latter definition MF is understood as providing loans for “income generating activities” or for “micro-enterprise development”. It is clear that the two above-mentioned ways are very different in objectives, methodologies, systems and operations. And of course the key issue is where the money comes from to fund the different organisations and activities.

If MF is about safeguarding poor and so far unbanked people’s money and providing them with safe, rapid and professional financial services, deposits, transfers, investments, loans, then MF becomes a tool of the formal, regulated financial sector; the banking sector. As such, local authorities need to manage a suitable regulatory framework and ensure its full compliance.

If MF is a social service for different sectors in society then again it does also become an issue for local government. Government, local companies, civil society and different citizens have legitimate interests for requesting that there is a system that brings some sort of stability and reliability in the social service, in the quality and exchange of goods and services, in the rights and obligations of providers and recipients, and in its funding.

Again to use a hypothetical method of developing an argument, if MF is a part of the formal financial sector, then MF products and services are offered by institutions that have a license under the financial sector regulation. Having such a license brings many responsibilities and obligations, regarding the way the MF services provider (MFSP) is organised, is funded and how it operates, including in relationship to other licensed financial services providers. As such a MF services provider operates in the financial market, as a bank or a non-bank specialised financial institution (NBFI). An NBFI can be a consumer lender, a specialised lending company targeting specific poor people, housing lenders. There can also be need for specific banks, such as banks specialised in agriculture, specifically to integrate MF into the bank sector, or others. All depends in fact on the origin and evolution of all MF operators in a country and why and how they want to transform and integrate into the banking sector. Operating in a market means that the MFSP provides data to the specific (financial) market regulator, helps to make the market work in a transparent manner, complying with the different rules and thus also contributing to getting the trust of all parties interested in the market including poor so far unbanked people MF is supposed to help. Trust (the English word for the Latin term “credit”) is needed from all market parties to establish, build and sustain the market. Such parties include all suppliers to an MFSP, from office builders, to furniture makers, water and electricity providers, car companies (sale or rental) etc, etc. Such parties are also local businessmen and private sources who look at opportunities for investment for whatever motive (charitable or commercial).

If MF is a Social Service, then it is characterised by a system that according to specific rules re-distributes money from specific sources to specific targets. As money is always a “rare good”, abuse by fund providers, operators and recipients needs to be avoided. There thus also needs to be transparency in the “market” of social services. As Government is the sovereign leader in a certain country and as there are distinctively different objectives and recipients for social MF services, mainly defined as loans, bringing a certain “market order” to social micro-credit concerns different government departments, such as Social Affairs, Employment, Unemployment, Enterprise Development, Economic Affairs, Agriculture, Women, Youth, Elderly.

Now, having tried to briefly explain that Microfinance can be understood in basically two different ways and that in both ways there is an important legitimate reason for some basic market order, I would like to add two other issues. One concerns the basic aim of effective, successful poverty alleviation. Providing poor people with constant, reliable access to basic quality goods and services for survival is very expensive: the provision of food, water, shelter, health care, physical security (protection and a legal justice system), education, transport and so on. Furthermore, all people strive to become self-sufficient in purchasing themselves the goods and services that they and their households need. They also want to have a say in the goods and services and the system that provides them. There are thus at least two basic dynamics that want to make poor, dependent people to be “poor-no-more”. Local poverty alleviation is thus directed towards succeeding in getting poor people out of poverty permanently. That sets it principally apart from the motives and objectives of foreign donors who basically limit themselves to helping poor people.

The second issue is that many concerns in lending to many different sectors and areas of country and society for social objectives have consequences for the local economy. If there are many poor people in a country and if micro-lending programs represent large sums of money relative to the local economy, then it affects the production and distribution of goods and services. For instance if food, water, housing, health care and other goods and services are provided for free to many then it is a factor that makes it difficult for an individual to start a private company to produce and offer those goods and services to clients. Such massive distribution of free services also puts huge pressure on public resources. This basic example might be ridiculously simple for some, I know. What I want with making it simple is to have a broad agreement with the readers, that if poverty alleviation is expensive and if poor people want to become reliant on their own money to purchase goods and services as and when they want, there needs to be a market entry point. There needs to be a motive for private providers and there needs to be regulation on pricing and standards, i.e. regulation that ensures transparency in prices set on specific services (including all real costs for a service defined by sort, quality etc.) and that prices can evolve in a rhythm that accompanies local market development.

Free provision of food, water and many, many other basic goods and services influences many different markets, in fact each good and service requires a different market with specific goals, systems, rules, expertise and so on. I hope it is clear that the free provision of many goods and services also influences the financial sector, the market for financial products and services. If many goods and services are produced and distributed in a Social Affairs system, then their transfer is an administrative decision, the funder or the responsible political department and its executive administrative body determines how and to whom distribution, allocation, transfer takes place. There is no private sector intermediary who can set a price to be remunerated for its role and the final recipient. The needy poor also have no power to determine conditions on the quality of goods, the distribution system and on the actual transfer. Only if the poor would have money and they would be allowed to choose for themselves would there be more need for financial services and for financial services providers.

The jump then becomes logical to argue that social credit delivery influences the possibility and the extent of Microfinance to develop as an institution and a tool within the regulated financial sector. It will also become clear that there is a very sensitive balance between many different organisations within a country that determine whether a poor citizen will become an individual that can build her or his own life with his and her loved ones or whether they will remain dependent on local government and foreign donors for being alive.

And so it hopefully becomes visible to the readers that I wanted to explain and support why in Microfinance, whether one defines and supports it as a part of the banking sector or as a social service, both sides created and broadened the need for sustainability in microfinance and the need for protection of the rights of the planned clients (often also called beneficiaries[1]) of Microfinance, poor people, who do not want to be poor and who have a right to take care of themselves.

But then, do the supporters of Microfinance provide the right tools to Microfinance to become sustainable? Do the tools allow beneficiaries to move from target recipients to become money owning deciders of their own lives? Do the tools allow local governments and citizens to work together to build a self-sustainable economy that can also take care of its poorest citizens? What is the impact of foreign agents imposing foreign standards and rating the performance of local MFIs and rating purely local processes?

For a move towards self-sustainability some performance indicators seem to make sense:-

1. An important role of local financial sources;
2. Local, diversified, ownership;
3. Local laws and regulations (developed and regularly reviewed by local authorities within a local process) whose supervision (compliance) is funded locally;
4. The number of accounts that local people have in regulated social and financial institutions;
5. The money that beneficiaries manage themselves on such social or financial accounts;
6. The complaints that individual beneficiaries have submitted to providers;
7. The identity of the recipients of such individual complaints and the outcome of the process.

In countries that define MF as lending to “income generating activities” or to “micro-enterprises” the following indicators seem only logical:-

8. How many enterprises have been created per year?;
9. How many enterprises fail over a year?;
10. How many non-family jobs have the enterprises created per year and
11. How many non-family jobs have been lost over the year?
12. Who collects and monitors the data on enterprise and job creation and how is that body and activity regulated in a country?

Following a variety of sources of research and provision on/of Microfinance services I now read a lot on the continuity of foreign funding (in the form of loans, investments and grants) dominating Microfinance and on the voluntary character of Codes of Conduct for MFSP to be transparent in pricing and in treating clients. I have yet to see one study on the actual bridging effect of foreign socially responsible investors in MF, that the support of the investors has achieved more sustainable local funding in the form of local loans, investment or the deposits of the poor clients themselves. I have yet to read any documents of foreign MF donors who want to fully apply the United Nations guidelines for consumer protection that date 1985[2], well over a quarter of a century ago. And I have yet to read one study on sustained enterprise and job creation[3] and growth produced by micro-credits. And finally, I have yet to hear Professor Yunus explain on the global media that the secret of GrameenBank’s success is that its board members (owners, shareholders) are local, its management is local, that its operational funding comes from profits (retained earnings) and loan funding from customer deposits.

But I can share with you some of my own experience. Only foreign donors seem to fund work on studying how MF policy and regulation should best be developed. Foreign donors and foreign consultants in MF also regularly express their preference to avoid local politics. And they also seem to prefer that local regulations do not hold foreign funders effectively accountable for making MFSP more sustainable. Many prefer not to be obliged to work with local government authorities. They ask me to understand that it is not important to prescribe that the performance of MFSP needs to be adjusted to any kind of subsidies and it represents no risk to the financial system when MFIs are not obliged to have owners, management and systems that can safely handle cash money themselves. In fact any kind of obligations towards funding and financial performance seems to represent “over-regulation” to them. Arguing that it also seems that donors and foreign consultants are a bit confused or paradoxical in their opinions and actions is not the right way; an individual opinion is simply put aside. Foreign donors and foreign socially responsible investors seem to agree that it is better to have a set of voluntary principles of responsible investment according to which they promise to act. That foreign determined voluntary principles, foreign quality standards and foreign performance rating help to eventually develop local processes I fail to understand. That it undermines or even precludes locally owned processes, is an opinion that foreign donors find plainly naive or even dangerously obstructive. But I also did read one recent study that led a foreign “socially responsible investor” in Microfinance to withdraw from a Micro-Credit Institution because, after ten years of support, all funding still came from foreign socially responsible investors, even with a specific license the MFI sees little need for collecting client deposits, loans go mainly to commerce and services, agencies open mainly in urban areas, and cash is handled (loan disbursement, repayments) by commercial banks. That last study did make me a bit happy, gave me a reason to continue in my stubborn commitment towards making common sense in Microfinance.

3 June 2011, BSD City, Indonesia

[1] There are reasons for disliking the term “beneficiaries” – are buyers from Shell or WalMart beneficiaries?

[2] On this issue I would like to strongly recommend “A Guide to Developing Consumer Protection Law”, published last month by (UK-based global association) Consumers International and written by Mrs. Jami Solli. It is a “must read” for all people who consider that poor people have the same rights as all other citizens have.

[3] Please refer me to one such longitudinal evidence-based study of UN organizations concerned with sustained economic growth such as UNCTAD (UN Conference on Trade and Development and ILO (International Labor Office). ILO’s Mission is to “Promote Jobs and Protect People”. Or has SEEP produced any such study, a global network of Micro-enterprise Development organizations that also provides well-known practical tools in Micro-Finance (CGAP promotes).