Microfinance Macro Potential

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By Prashant Thakker- LONDON – Microfinance is, at its heart, an effort to provide financial services to
people who are not served – or are under-served – by the formal banking system. With
appropriate, accessible, and fairly priced financial services, people can build
their savings, cover the costs of unexpected emergencies, and invest in their
families’ health, housing, and education.

The International Finance Corporation estimates that microfinance has reached some
130 million people worldwide in the last 15 years. Over this period, microfinance
has been lauded for its potential to advance financial inclusion and enable people
to escape poverty. But it has also faced harsh criticism, with some lenders being
accused of profiteering.

Despite the industry’s widely publicized pitfalls, its potential to improve the
lives of the poor cannot be ignored. The question now is how to ensure that
microfinance becomes the industry that the world needs. To this end, three important
steps must be taken.

The first step is better regulation. Microfinance institutions (MFIs) come in many
forms – mainstream banks, specially licensed banks, non-financial companies, finance
and leasing companies, non-governmental organizations, cooperatives, and trusts –
and follow a variety of business models. All of these intermediaries must be
recognized and regulated according to the needs of the economies in which they

Inadequate regulation is most damaging to those who need microfinance services the
most. Nowhere was this more apparent than in the 2010 microfinance crisis in the
Indian state of Andhra Pradesh – a hub of MFI activity – when a decade of explosive
growth, fueled by aggressive and reckless lending practices, came to a head.

Over-indebtedness, together with coercive recovery practices, led to a series of
widely publicized suicides, spurring local officials to implement new restrictions
on MFIs and discourage borrowers from repaying their debts. As repayment rates
plummeted, micro-lending ground to a halt.

In order to prevent such outcomes, governments must design regulations that foster a
sustainable financial-inclusion model, one that enables MFIs to offer long-term
support to borrowers. At the same time, regulation must deter MFIs from behaving
recklessly with a vulnerable client segment. And regulation should be based not on
past experience, as it is now, but on future possibilities; in other words, the
regulatory framework must be flexible enough to accommodate new innovations.

The second step, to be taken by the microfinance industry itself, is to create
effective mechanisms for assessing the industry’s impact. As it stands, some
governments and academics are uncomfortable with the fact that MFIs, which are
supposed to be providing a public good by advancing financial inclusiveness, are
pursuing profits.

But the failure of some MFIs to differentiate between profit-seeking and
profiteering does not mean that sustainable microfinance should not yield returns
above costs. The business of providing financial services to the poor requires
commitment. Without profits, MFIs are unable to invest in the talent and product
development needed to serve people for the long term.

Many governments have now implemented interest-rate ceilings and margin caps to
curtail excessive profits for MFIs, while ignoring the margins of the market’s
non-organized alternatives, like pawnbrokers. In order to provide a more balanced
perspective on the microfinance industry compared to other kinds of
financial-services providers, MFIs need to do more to measure and explain their
social and economic value.

The good news is that industry bodies, investors, and governments have already
introduced metrics for factors ranging from pricing to conduct. While this has
resulted in a rather disparate set of indicators, which must be standardized, such
efforts are an encouraging sign of the microfinance industry’s commitment to
securing its role in the financial-services ecosystem.

The third step concerns technology. Mobile connectivity is transforming the global
financial system by enabling remote, rural populations to access financial services
for the first time. Mobile-payment systems like M-Pesa are changing how people
transfer, receive, and save money in many developing countries, including Kenya,
Pakistan, and the Philippines.

For the microfinance industry, such systems represent an important opportunity, as
they enable borrowers to apply for, receive, and repay loans on their mobile phones,
using a network of local agents to deposit and withdraw cash. But, without robust
regulation, MFIs cannot make the most of these developments.

Moreover, the mobile-payments revolution has so far been led largely by telecom
providers. If it is to deliver real benefits to the financially excluded, the
financial-services industry will need to play a much more active role.

Of course, microfinance alone will not eliminate poverty, or even financial
exclusion, regardless of how well it functions. To have a truly transformative
impact, MFIs’ operations must be supported by government-led efforts to improve
access to education, training, and employment.

Although microfinance has already helped countless people worldwide, the World Bank
estimates that some 2.5 billion adults still lack access to financial services. It
is the responsibility of all stakeholders – including governments, regulators,
banks, and civil society – to ensure that microfinance continues to be part of the

Prashant Thakker is Global Business Head of Microfinance at Standard Chartered.

source : Project Syndicate, 2013.

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