In the International Year of Microcredit, the UNDP’s Mark Malloch Brown encourages more commercial banks to take up microfinance.

Microfinance is helping to transform the lives of millions of people, helping to build businesses, create jobs and lift men, women and children out of poverty.

It has a critical role to play in global development efforts, not least in achieving the internationally agreed Millennium Development Goals.The focus in the past two decades has been to expand microloans to support the economic activities of the poor. Now, given the scale of development challenges, the broader concept of microfinance – encompassing a range of financial services, including lending, savings and insurance – will be critical.

The aim of microfinance is to help poor and low-income clients to meet their basic needs and invest for the future according to their own priorities. With microfinance, poor people are better able to build their income and assets, manage their household expenses and insure against the risks they face. With access to micro-insurance, the poor can cope with the sudden expenses associated with serious illness or loss of assets; with access to banks for transferring funds, workers can send money home so that relatives can cover expenses and even start businesses. And with sustainable access to credit and savings, poor households can invest in housing, healthcare and education for their children.

Restricted access

Potentially, about 500 million people could benefit from microfinance services today, yet only 6% have access to such services. An inclusive financial sector should offer the vast majority of the population sustainable access to a range of services suited to their needs. Such a sector should be characterised first by household and micro and small enterprise access to a full range of financial services (savings, short-term and long-term credit, mortgages, insurance, pensions, remittances and leasing) for production as well as for family insurance. Secondly, the sector should be characterised by the sustainability (cost-effective provision) of these services.

In the International Year of Microcredit, the greatest challenge is to build inclusive financial sectors that serve the interests of the poor, helping them to work their way out of poverty and generate the kind of economic growth that is vital to human development.

Grassroots action

During the past 25 years, thousands of microfinance non-governmental organisations (NGOs) have been established, particularly in Asia, Africa and Latin America, providing hundreds of thousands of people (individuals and groups) with microloans. Many of these institutions have been remarkably successful. The world’s largest NGO, BRAC (formerly the Bangladesh Rural Advancement Committee), has played a central role in extending small loans, mainly focused on women, with more than $2bn in micro credit loans disbursed, and a 98% repayment rate. And the ASA institution in Bangladesh is one of the most efficient microfinance NGOs in the world, with an adjusted return on assets of 12%.

Across the world, experience has demonstrated that microfinance institutions can provide microloans to poor people in an efficient and financially sustainable way. Microfinance has fared well in good times and bad, with returns uncorrelated with those from other asset classes. At the height of Indonesia’s financial crisis in 1998, for example, the portfolio at risk at Bank Rakyat, Indonesia’s Unit Desa microfinance village banks with more than three million microfinance clients, was less than 6%, while the level of non-performing loans in Indonesia’s banking system at the same time was more than 60%.

Increasingly, therefore, microfinance is being seen less as a charitable function and more as part of building an inclusive financial sector that is dedicated to meeting the financial needs of poor clients in a responsive and profitable manner. In other words, it is becoming a mainstream business model. An approach that recognises the important roles of both regulated and unregulated institutions in the microfinance system is essential. Grassroots savings and credit groups, and microfinance NGOs, along with universal commercial banks, finance companies, co-operative banks, regulated microfinance institutions (MFIs), insurance companies and wholesale financing institutions, all have a critical part to play in extending financial services to all sections of society. This endeavour will require new forms of partnership and dynamic and creative ways of working.

The role of commercial banks

In the past five years, a number of private mainstream commercial banks, finance companies and insurance firms have entered the microfinance sector as retailers or wholesalers. Banks have provided refinance facilities to NGOs, linking them to financial markets, and have launched retail microfinance operations. As a result, they have moved microfinance to the mainstream, using better technology and more sophisticated risk management and information systems. Many of these institutions see the large potential market for microfinance, and most of them employ senior staff who are motivated by community concerns as well as profits. These traditional financial institutions have learned from MFIs and pioneer banks how to reduce the high transaction costs of microlending.

Some government banks have also established large, efficient and profitable microfinance operations – breaking from the tradition of low efficiency, low profitability, low repayment and subsidy approaches to lending to the poor.

The benefits for commercial banks are clear. Most mainstream financial institutions are not resource-constrained: they have established broad-based savings mobilisation and are fully integrated into domestic financial markets. Major coverage in microfinance can therefore be achieved with a small percentage of a bank’s assets.

Microfinance has caught the attention of some of the world’s leading financial institutions, both international and domestic. Internationally, Citigroup, Deutsche Bank, Santander, ING and ABN AMRO are seeing microfinance as a profitable opportunity. Socially responsible banks and funds have also targeted this huge market. Oiko Credit and Triodos Bank, both in the Netherlands, are finding ways to extend local currency loans to high performing microfinance institutions around the world. Blue Orchard Finance in Switzerland has launched the first international asset-backed securitisation deal, issuing US dollar-denominated microfinance bonds with a guarantee from the Overseas Private Investment Corporation; the proceeds from this offering are expected to help 40,000 micro-entrepreneurs in Latin America, Asia, Africa and eastern Europe.

On the domestic front, commercial banks are developing relationships with microfinance banks through wholesale lending, supporting bond issues and securitisation. There is evidence that microfinance institutions are increasing their leverage in domestic capital markets where there is still significant capacity for microfinance institutions to access bank funding, provided that local capital market conditions are favourable. Retail banks are also expanding their client base by offering microloans. ICICI Bank in India has been at the forefront of funding microfinance institutions that show promise and it is exploring ways of developing its own retail capacity. Bringing poor clients into the fold can be a way of building loyalty that will pay off over the years.

Today, there is a clear shift in the microfinance industry away from donor funding and toward commercial sources of funding, including the mobilisation of domestic savings. Microfinance NGOs are therefore scaling up their activities and becoming regulated financial institutions, while larger commercial banks are downscaling their operations to reap the benefits that this emerging asset class has to offer. This brings real promise to the goal of building inclusive financial sectors that benefit the poor. The increasing involvement of commercial banks in microfinance is critical if financial sectors are to be structured in a way that will help to ensure that both the poor and the poorest in developing countries have access to financial services.

International Year of Microcredit

2005 marks a critical year in the evolution of the microfinance movement. The International Year of Microcredit calls for building inclusive financial sectors and concrete actions to strengthen the often untapped entrepreneurial spirit that exists in communities around the world. This is a unique window of opportunity to ensure that microfinance can transform development and create jobs, business and economic growth in a way that enables microfinance to take its proper place as one of the main contributors to achieving the Millennium Development Goals.

The international year offers a challenge to national governments, central banks and supervisory bodies, multilateral institutions, the private sector (including the wide range of financial institutions), civil society and other stakeholders in the microfinance industry to work in partnership to assess and promote the power of microfinance so as to improve individual lives, communities and whole countries.

It could be said that microfinance offers the ultimate win-win proposition: profitability and social impact.

Mark Malloch Brown is head of the United Nations Development Programme and has recently been appointed UN chief of staff

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