What is Microfinance?

Submitted by mffocus on Wed, 09/07/2011 - 22:55

Microfinance Focus, September 7, 2011: Microfinance is a growing phenomenon in many countries. However, each country has its own distinct way of practicing microfinance suitable to their economy and society.

By asking the question ‘What is Microfinance?’ this article aims to provide a list of various countries displaying how microfinance is defined. Browse through each country to find out how microfinance is defined. Through this you will find both diverging and converging characteristics in each microfinance sector.

Microfinance is becoming an increasing important tool for addressing the problem of poverty in many developing countries. Therefore, many governments and institutions recognize the need to create a stable and credible microfinance sector in their country.

Compare and contrast what microfinance is in Nigeria, India, Bangladesh, Philippines, Kenya, Pakistan, Indonesia, Thailand and Vietnam.

Nigeria

According to the Central Bank of Nigeria (CBN), “a microfinance loan is a facility granted to an individual or a group of borrowers whose principal source of income is derived from business activities involving the production or sale of goods and services”. The loans should not exceed N500, 000 or and as may be reviewed case by case by the CBN.

Generally, a microfinance loan is granted to the operators of micro-enterprises, such as peasant farmers, artisans, fishermen, women, senior citizens and non-salaried workers in the formal and informal sectors. The loans are unsecured, granted on the basis on the applicants profile and the combined cash flow of the business and household. The tenure for a microfinance loan is usually 6 months but, in the case of crops with longer gestation period, a maximum tenure of 12 months is given.

[Source]

India

In the Micro Finance Institutions (Development and Regulations) Bill 2011, defines microfinance services as one or more of the following financial services involving small amounts to individuals or groups: (i) providing micro credit; (ii) collection of thrift; (iii) remittance of funds; (iv) providing pension or insurance services; (v) any other services as may be specified.

In a draft document of the Microfinance Institutions (Development and Regulation) Bill 2011, microfinance services means one or more of the following services: (i) financial assistance to an eligible client for an amount, not exceeding rupees fifty thousand in aggregate per individual, for small and tiny enterprise, agriculture, allied activities (including for consumption purposes of such individual); or an amount not exceeding rupees one lakh fifty thousand in aggregate per individual for housing purposes; or such other amounts, for any of the purposes as may be prescribed; (ii) financial services to an eligible client through such agent as may be permitted by the Reserve Bank; (iii) life insurance or general insurance services or pension services to an eligible client, which have been approved by the authority regulating such services; or (iv) any other services.

One of the first few definitions of microfinance in India is the “provision of thrift, credit and other financial services and products of very small amounts to the poor in rural, semi-urban and urban areas for enabling them to raise their income levels and improve living standards”. This definition was proposed by the Task Force on Supportive Policy and Regulatory Framework for Micro- Finance set up by the National Bank for Agriculture and Rural Development (NABARD) in 1999.

[Source 1 , 2 ]

Bangladesh

The Grameen Bank Ordinance 1983, was the first law to govern the rural credit market. Therefore based on the Grameen Bank Ordinance, the Grameen Bank was established to provide credit facilities and other services to landless persons in the rural areas and to provide for other related matters. A microfinance loan “includes guarantee or indemnity which the Bank may give on behalf of a landless person or any liability which the Bank may incur on behalf of a landless person.”

Since then, the Government of Bangladesh came up with the Micro Credit Regulatory Authority Act in 2006. Accordingly, micro credit “means loan facilities offered by micro credit organization certified under this Act for poverty alleviation, employment generation and facilitate a small entrepreneur.” Also a micro credit organization needs to be certified to operate run micro credit program under this Act and registered under The Societies Registration Act 1860, The Trust Act 1882, The Voluntary Social Welfare Agencies (Registration and Control) Ordinance 1961, Samabaya Samity Ain or Company Ain.

In Bangladesh there are mainly four types of institutions involved in microfinance activities. These include the Grameen Bank, more than thousand non-government organizations out of which about 500 are licensed MFIs, commercial and specialized banks, and Government sponsored microfinance programs such as Bangladesh Rural Development Board (BRDB).

[ Source 1, 2 , 3 ]

Philippines

In 2000, microfinance became a legitimate banking activity in the Philippines. The Banko Sentral Ng Pilipinas (BSP) with respect to the General Banking Law states that “microfinancing loans are small loans granted to the basic sectors, as defined in the Social Reform and Poverty Alleviation Act of 1997 (Republic Act 8425), and other loans granted to the poor and low-income households for their microenterprises and small businesses so as to enable them to raise their income levels and improve their living standards”.

Microfinance loans are granted on the basis of the borrowers’ cash flow and are typically unsecured. The maximum principal amount of microfinance loans shall not exceed P150,000.

[Source]

Kenya

The Central Bank of Kenya states in its Microfinance Act in 2006 that “a microfinance business in which the person conducting the business holds himself out as accepting deposits on a day-to-day basis; and any other activity of the business which is financed, wholly or to a material extent, by lending or extending credit for the account and at the risk of the person accepting he deposit, including the provision of short-term loans to small or micro enterprises or low income households and characterized by the use of collateral substitutes”.

[Source]

Pakistan

The Microfinance Institutions Ordinance 2001 by the State Bank of Pakistan defines microfinance services as “the financial and other related services specified in section 6, the value of which does not exceed such amount as the State Bank may, from time to time, determine”. A microfinance institution is “an institution, which extends micro credit and allied services to the poor through sources other than public savings and deposits”.

The powers and functions of microfinance institutions in Pakistan include providing financing facilities, with or without collateral security, to poor persons for all types of economic activities; to provide professional advice to poor persons regarding investments in small business and such cottage industries; to invest in shares of anybody corporate, the objective of which is to provide microfinance services and technical, vocational, education, business development and allied services to the poor and micro enterprises etc.

[Source]

Thailand

The microfinance sector in Thailand is highly regulated and controlled by the Thai government. The Bank of Thailand (BOT) in 2011, allowed commercial banks to engage in microfinance, whereby there is no collateral requirement, a credit limit of THB 200,000 (USD 6,000) and an annual interest rate cap of 28 percent.

Thailand’s microfinance sector has three categories: 1) Formal sector that involves commercial banks, financial companies, credit fonciers, SME Bank, insurance companies, and non-bank financial institutions. The credit coverage of the formal aspect is THB 7.730 trillion. 2) Semi-formal sector that includes Village ad Urban Communities Revolving Fund, agricultural/ savings/ credit union cooperatives and registered savings for production groups. The credit coverage of the semi-formal aspect is THB 860 billion. 3) Self-help groups that consists of Saja savings groups, village bank, NGOs MFIs and other financial intermediary organizations. The credit coverage is THB 30 billion.

[Source 1, 2]

Vietnam

Currently, The Vietnam Microfinance Working Group’s microfinance programs are providing services to approximately 500,000 households nationwide. This year, the Government of Vietnam issued a decree, Decree 28, amending the organization and operation of microfinance. This Decree provides a legal framework for microfinance organizations to facilitate their active and comprehensive development.

The Working Capital Fund (CEP), part of the Vietnam Microfinance Working Group, has adopted the international standards related to financial reporting, accounting policies and credit management, increasing transparency to help the working poor self-employment. For instance one of its policies is to allow a 3 million. This replaces the previous policy of borrowing a second round of 2 million with an 18-month loan period and interest payment every month. The 3 million loan duration is 24 months and the 5 million loan duration is 36 months. Loan within the first 1 million should be repaid in 12 months and the monthly amortization of principal is kept intact.

[Source]

South Africa

The microfinance industry in South Africa is governed by the Usury Act. Specifically, the Usury Exemption Notice 1 June 1999, defines the perimeters of microfinance lending to these conditions: (i) The loan amount did not exceed R10 000, (ii) The repayment period did not exceed 36 months; and (iii) The loan amount was not paid in terms of a credit card scheme or withdrawn from a cheque account so as to leave the account with a debit balance.

The Micro Finance Regulatory Council (MFRC) has been established in accordance with the Usury Act Exemption Notice of 1 June 1999. The MFRC, is a company incorporated under Section 21 of the Companies Act, and has been recognized as the official and single regulator of all money lending transactions falling within the scope of the Usury Act Exemption Notice.

[ Source 1, 2 ]

This article will be updated with various other countries.

1.The timing of the question

Submitted by Dr V.Rengarajan (not verified) on Wed, 12/28/2011 - 17:40.

1.The timing of the question has created both unfortunate and fortunate situations in this industry.
It is unfortunate in the sense that probing this fundamental question on microfinance after three decades of practices, research, guidance, conferences .workshops, Summits, intellectual debates, ‘e’ discussions and summits both at national and global levels, appears to be too late for taking cognizance of the facts for rejuvenation of or process reengineering in this industry.
At the same time, it is fortunate in terms of looking into the emergence of this basic query at latest after having witnessed seven crisis and unbridled over indebtedness in this industry and continued existence of poor status of the poor as it is better late than never for searching some prescription for financial syndrome, based on the learnt lessons in this sector. It is better late than never!
2. Country wise practice of Microfinance as posted above indicate a diversified appreciation on the concept and the values of Microfinance without calrity. There is no uniformity in the coverage of target group, and the type of MF products. Institutional formalities have bee more focused from supply side rather the dynamics of demand side for whom the whole MF concept has emerged.. At least in India , NABARD Task force has brought a comprehensive definition of micro finance covering all MF services for the poor. This apart, ,the definitions of Micro finance of multi-national institutions like WB ADB CGAP also broadly indicate all MF services for the poor. What ever preached , it is not practiced ethically .Whatever practiced it is glorified unethically in this industry.
3. Albeit diversification in MF practices, whatever services mostly confined to micro credit would serve the purpose partially or fully to the particular segment or the sector. Covered by it. But is it adequate for sustainable poverty cure in the context of lack of appreciation on poverty profile in the pyramid with multiple needs and administration of micro credit product alone ?
4. A candid MFI capable of providing all pro poor MF services holistically integrated with other support services with proper sequencing to the target group either singly or severally is yet to emerge! In that case, reaching MDG is not difficult.
Dr Rengarajan

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Submitted by admin on Tue, 09/13/2011 - 14:50.

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What is MF: a tool to keep the poor there where they are

Submitted by peter van dijk (not verified) on Fri, 09/09/2011 - 08:17.

Thank you MF Focus for this continuing initiative and the opportunity to discuss the most important issue: what is it we are working on and for?

In the series of countries you list, government define MF as very small sums of money mainly for poor people who (want to) undertake very small unregulated businesses. You thus only qualify for the service, most often a loan, when you are poor and have a micro-business.

You don't qualify when you are not poor or when you don't have an enterprise. That means, consequently, that a MF services providers only deals with people that are defined as poor. Thus one needs to look at the definition of who is poor in the social policy starting by who is poorest. And MFIs need to always bear in mind to not get carried away, no "Mission Drift" as it is called, to accompany the poor out of poverty. The non- or maybe even the less poor should go elsewhere, regardless whether they want or have an alternative (depending on how much money there is to "lend away"). It also means that a MF services provider is forced to only work with high cost and risk clients and that it needs to qualify by social definitions. Interest rates and profits need to be constantly watched and defended as not being too high.

And only people two undertake a businesses can qualify for loans, which means the following:
- attention that credit is only used for the business (not for the household)
- not to housewives and not for housing, clothing, children, healthcare, education, transport, food
- not to beggars and not to anyone else who is situated on the lowest step of society, they need to depend on social welfare, charity. Too bad if there is only a micro-lender in their neighborhood.

The following results are thus most likely to be produced:
1. The poor borrowers remain poor, maybe a bit less poor at the time the loan is received
2. Micro-Finance Institutions will less likely become sustainable so why should central banks regulate them? Why should Micro-Credit NGOS be regulated by central bank at all?
3. GrameenBank, BRAC Bank are not Micro-Finance Institutions but retail banks (deposit led, flexible loans to individuals including consumer loans, loans for education etcetera and profitable)
4. All MFIs who give consumer loans or loans used for food, transport, education etcetera should stop, pay fines or become social NGOs
5. The poor who want to receive these monies need to demonstrate that they have and undertake a business and that the loan is used for that business.

And it means that undersigned has a lot of work to argue otherwise, namely hat MF means two things: 1. to integrate so far unbanked people and areas into the formal financial sector and 2. loans to people and activities targeted for social objectives but fire-walled from the formal financial sector so that it cannot undermine 1.

Cheers, Peter

Peter van Dijk
BSD City, Indonesia