Microfinance and the Poor

• Author: Elizabeth Littlefield/Richard Rosenberg
• Position: Chief Executive Officer of the Consultative Group to Assist the Poor (CGAP)/Senior Advisor on policy issues at CGAP
• Pages: 38-40

Breaking down walls between microfinance and formal finance

Page 38

Contrary to a common impression, poor people need and use a variety of financial services, including deposits, loans, and other services. They use financial services for the same reasons as anyone else: to seize business opportunities, improve their homes, deal with other large expenses, and cope with emergencies. For centuries, the poor have used a wide range of providers to meet their financial needs. While most poor people lack access to banks and other formal financial institutions, informal systems like moneylenders, savings and credit clubs, and mutual insurance societies are pervasive in nearly every developing country. The poor can also tap into their other assets, such as animals, building materials, and cash under the mattress, when the need arises. Or, for example, a poor farmer may pledge a future season's crops to buy fertilizer on credit from commercial vendors.

However, the financial services usually available to the poor are limited in terms of cost, risk, and convenience. Cash under the mattress can be stolen and can lose value as a result of inflation. A cow cannot be divided and sold in parcels to meet small cash needs. Certain types of credit, especially from moneylenders, are extremely expensive. Rotating savings and credit clubs are risky and usually don't allow much flexibility in amount or in the timing of deposits and loans. Deposit accounts require minimum amounts and may have inflexible withdrawal rules. Loans from formal institutions usually have collateral requirements that exclude most of the poor.

Microfinance institutions (MFIs) have emerged over the past three decades to address this market failure and provide financial services to low-income clients. Most of the early pioneer organizations in the modern microfinance movement operated as nonprofit, socially motivated nongovernmental organizations. They developed new credit techniques: instead of requiring collateral, they reduced risk through group guarantees, appraisal of household cash flow, and small initial loans to test clients. Experience since then has shown that the poor repay uncollateralized loans reliably and are willing to pay the full cost of providing them: access is more important to them than cost.

The poor need and use a broad range of financial services, including deposit accounts, insurance, and the ability to transfer money to relatives living elsewhere. Experience has shown that the poor can be served profitably, on a long-term basis, and in some cases on a large scale. Indeed, well-run MFIs can outperform mainstream commercial banks in portfolio quality. The top-performing MFIs in some countries are more profitable than the top-performing local commercial bank.

In turbulent times, microfinance has been shown to be a more stable business than commercial banking. During Indonesia's 1997 crisis, for example, commercial bank portfolios deteriorated, but loan repayment among Bank Rakyat Indonesia's 26 million microclients barely declined. And, during the recent Bolivian banking crisis...