Spanda Journal | Microfinance: The Way Ahead

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O N L I N E E D I T I O N | W W W . S P A N D A . O R G / P U B L I C A T I O N S . H T M L

SPANDA.ORG

I,2/2010

S P A N D A

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M I C R O F I N A N C ET H E W A Y A H E A D

can move further, a purifying process that does notend with our own lives, but reaches back to thebeginning of our linage. To be known or unknown?

The creative process shapes theboundaries of the unknownwithin itself, un quantum tiral’altro, e così via. No past, nofuture. If you don’t bear thecourage to live now, it isbecause of fear. Cross thethreshold, leave fear behind andstep in, it is urgent.Fine, let’s now shape a few smallchanges into the known. Microchanges into a micro world, amicro-cosmos, a micro-finance.Micro what?!? Microfinance is aseed of prosperity to reach fur-ther away, away from whereNothing is king. It is a tool tohelp people move on, an agent toalleviate poverty, material poverty,educational poverty, health pover-ty, and spiritual poverty; eventhough spirituality is nowadays ablack hole within its engulfedmorphomagnetic field.According to UNDP findings,the far greater majority of theworld’s population is undevel-oped and unrepresented, our‘democracy’ does not take intoaccount their rights and allows

a small financial elite to govern the world. Theeconomic, environmental, political crises, and thepersonal, familial, work and health stress are inher-ently interconnected, and are the symptoms of an

In the tested way,knowledge is inferior to certainty but above opinion.Know that knowledge is a seeker of certainty,and certainty is a seeker of visionand intuition.RUMI, Mathnawi, III: 4115-4121.

H I L E AF R I C A I S P LU N G I N G

into nothingness andthe MDGs are becom-ing an infant dream,

we still envion a better world,a world of justice, of liberty, ofpeace and harmony, of spiritu-al and material health, and ofspiritual and material wealth.An ideal world too ideal to bereal. So let’s blend ‘ideality’ andreality into a single being: unity.Again and again unity is call-ing us with its powerful drive.Destiny is not a quirk entity tobe achieved, proscribed andunknown forever, a cometvesting our life, no, unlike fate– the immutable law of theuniverse, akin to dharma –destiny is indeed our potentialbecoming. “riverrum, past Eveand Adam’s, from swerve of shoreto bend of bay” as our friendwould say.When intention and action aresynchronic and devoid of self-interest – not even ofwanting to be or to do the ‘good’ – the ensuing actis pure and does not generate karma. Sooner or laterthe entire wheel will need to be purified before we

S P A N D A J O U R N A L I , 2 /2 0 1 0 | m i c r o f i n a n c e

E D I T O R I A L | SSAAHHLLAANN MMOOMMOOMicro What?AANNTTOONN SSIIMMAANNOOWWIITTZZQuality MicrofinanceMMAALLCCOOMM HHAARRPPEERRMicrofinance and thePreservation of PovertyJJEENNNNIIFFEERR MM.. BBRRIINNKKEERRHHOOFFFFMaximising the Effectivenessof Microenterprise DevelopmentJJOONNAATTHHAANN HH.. WWEESSTTOOVVEERRThe Impact of MicrofinanceProgrammes on PovertyReductionSSIIMMOONNAA SSAAPPIIEENNZZAAMicrofinance Yesterday,Today and TomorrowAANNAANNTT JJAAYYAANNTT NNAATTUUMarket Strategy Developmentand 3rd GenerationMicrofinance in IndiaAALLBBEERRTTOO BBRRUUGGNNOONNIIA Shariah-compliant

Microfinance FundMMAANNOOJJ KK.. SSHHAARRMMAA ~~GGRRAAHHAAMM AA..NN.. WWRRIIGGHHTTTime to Go Back to Basics?A B S T R A C T S

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S PA N D A J O U R N A L

MICROWHAT?

SPANDA.ORGSPANDA.ORG

I,2/2010

EDITORIAL

unavoidable evolutionary breakthrough in individ-ual and collective development. Whose genius loco,loci, locum, is this? Our individual, social and eco-logical capacity to deal with change and distur-bances and nonetheless to continue to develop, inother words our resilience, is our natural and socialcapital, crucial in maintaining options for furtherhuman development. In complex adaptive sys-tems, co-creation and co-management stimulatessustainable development and enhances resilience inboth humanand natural sys-tems. In thecurrent microfi-nance scenario,banks are piv-otal instrumentsand hold an eth-ical responsibilityon how the flowof monies ischannelled bymeans of micro-finance institu-tions to empow-er the poor.Since all theirtransactions aresolidly and inten-tionally imbedded inprofit, ignoring anysort of co-managementwith the end beneficiaries,their imprinting reaches downthe very end of the chain bearingin itself that original ‘sin’. Even thoughcredit institutions maintain thatmoney does not have a master, moneyis their own master, their sole Goal,with the financial elite as puppeteer.Money is matter, and matter is made upof the same energy of thought, beingmatter just a special kind of solidifiedthought – thoughts are matter,thoughts are things. To communicate,we need to encode our thoughts andperceptions in formal verbal symbol –at ‘times’ it is hard: many overlappinginputs, entropy: then stillness. Wherethere is no thought there is radiance. Where thereis not thought there is splendour. Where there isno thought there is you, finally.Finally, we begin to perceive that there is neitherme nor you, nor he or she, nor them or thee: butonly one. Vision and intuition are in sight, enoughto follow the attracting radiance of the light infront of us. Peace at last, peace didn’t allow usmany things, but gave us more than we couldhave ever hoped for.

Poi cominciò: “Io dico, e non dimando,Quel che tu vuoli udir, perch’io l’ho vistolà ’ve s’appunta ogni ubi e ogni quandoDANTE, Divina Commedia, 3, XXIX: 10-12.

All images are merely images, phantoms on the screenof consciousness, on the mundus imaginalis, that‘eighth climate’ behind whose veil shines the light.“Hu Hu – said the father – who is there?” It’s me! Yourhumble idiot arcing the Way, whom for a while sailedyour bay. “I saw pain in your eyes before you left”, I

would have liked to have the nerveto say I love before. ©

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S P A N D A J O U R N A L I , 2 /2 0 1 0 | m i c r o f i n a n c e | 3

Anton Simanowitz is researcher atthe Institute of Development Studies,University of Sussex, UK. He was afounder and for five years Director ofthe Imp-Act Consortium (www.Imp-Act.org). Imp-Act supports and pro-motes the management of social per-formance in microfinance, providingpractical lessons for practice andpublic policy. The Consortium’s Prac-tice Guide, Putting the ‘Social’ intoperformance management’ has beendownloaded more than 25,000 timessince its launch in December 2008,and is currently being translated intoSpanish, French, Russian and Arabic.A recently launched film presents thepractical experience of leading MFIs ofhow financial and social performancecan be balanced http://www.youtube.com/watch?v=WKesX9KJ-9M and theSPM network brings together morethan 1000 practitioners and supportersof microfinance www.spmnetwork.net.Anton is also Chief DevelopmentOfficer and Advisor to the Board of the Small EnterpriseFoundation (SEF), the largest developmental microfinanceorganisation in South Africa. His work with SEF focuses onimproving efficiency and effectiveness through strengtheningperformance management and systems to balance social andfinancial performance.

R E C E N T L Y H E A R D A B O U T A T E A M O F M A R K E T

researchers in Uganda, who were talking toclients of an MFI about what they liked anddisliked about the services. The clients

responded angrily about their treatment at thehands of field agents: “they are devils [… ] all theycare about is getting their money back”.This story from one of the most competitivemicrofinance markets got me thinking. Microfi-nance is coming of age, with accelerating growthin numbers of people reached and the financialvalue of the industry 1. Annual growth rates havebeen between 40 and 60 per cent in a number ofmarkets, with India growing 94 per cent perannum since 2003 2. Yet the potential market for

microfinance remains vast with some 2.5 billionpeople lacking access to even basic financial ser-vices. Scale drives profitability and profitabilitydrives scale, and the race is on to serve more andmore people and maintain the impressive returnsthat attract investment. But what do these num-

bers mean? Are we valuingwhat matters, and if not thenwhat are the consequences?

E N S U R I N G Q U A L I T Y A N D

R E S P O N S I B L E L E N D I N G

Increasing numbers of clientsis not by itself an indicator ofpositive impact or the strengthof an institution. The financialcrisis and subsequent recessionis exposing a loss of qualityand inadequate systems in par-ticular for ensuring responsiblelending and collection prac-tices in many MFIs.Competition and a desire togenerate high rates of return onequity so as to attract commer-cial investment and allow everfaster growth have led to multi-ple-lending and the pushing ofcredit. This combined with

erosion of client livelihoods through increasingfood prices, recession and retrenchment is leadingto over-indebtedness and client delinquency. Severedelinquency problems are occurring or predicted ina number of countries3, and a number of high pro-file, fast growing and seemly successful MFIs haverun into serious problems – Zakoura (Morocco),Opportunity Bank (Montenegro), Kashf (Pakistan)and First Microfinance Bank (Afganistan). Themost CSFI4 Banana Skins report for 2009 surveyconcluded that credit risk is now the number onechallenge for MFIs, demonstrating the impact onthe very foundation of microcredit – the ability ofclients to repay their loans. Like the famous pyramidschemes that feed off positive sentiment and col-lapse when confidence disappears, at least in somemarkets, it seems that in the rush for growth some ofthe fundamentals of responsible and quality businesshave been overlooked. At the heart of these failures lies the breakdown ofeffective systems for managing the fundamentalsof microfinance. High rates of growth put huge


Q U A L I T Y M I C R O F I N A N C ES U C C E S S F U L C L I E N T S A N D I N S T I T U T I O N S

A N T O N S I M A N O W I T Z

“ The greatest

of evil and

the worst

of crimes

is poverty. ”GG .. BB .. SS HH OO WW

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pressures on management systems, challenging theability to ensure consistency and quality in servicedelivery. The CGAP Banana Skins 2008 survey, forexample, named management weaknesses as thenumber one challenge for the industry. In additionto this pressure on systems a short-term prioritisa-tion of client numbers and return on equity divertsthe attention of management, Board and investorsaway from a double-bottom line that puts clientservice and success at the foundations of successfulmicrofinance.The need to ensure that systems and managementprocesses can secure an effective balance betweensocial and financial performance is illustrated by

the financial incentives that many MFIs provide totheir staff. These often make up a third of a fieldagent’s salary or more. Most incentive schemes inthe industry focus squarely on growth, commonlyrewarding three things: number of new clients;increase in portfolio outstanding; and arrears orportfolio at risk. That is to say that staff are incen-tivised to bring in as many clients as possible, giveout as much money as possible, and make sure thatthe money comes back. This leads to a potentialloss of quality in terms of not bringing in targetclients (who may be more time-consuming toreach), poor attention to assessing capacity torepay, and harsh debt collection methods. Therecognition of these problems, reflected in a num-ber of high profile media reports on the negativeimpacts of over-indebtedness, is leading to move-ment in the industry to be much clearer need totake action to avoid possible negative impacts of

microfinance – particularly over-indebtedness andharsh debt collection practices. Client protection isthus increasingly being seen as one of the key issuesfor the microfinance industry in the future5.

R E S P O N D I N G T O C L I E N T N E E D S

One of the defining features of poverty is theinability of poor people to cope with the inevitableproblems that life throws up – illness, natural dis-aster, death, creditors not repaying etc. How MFIsrespond to this vulnerability in the services theyoffer and in delinquency management makes ahuge different to their social outcomes, and is a

critical consideration for MFIs that seek to be respon-sible lenders.This issue is illustrated by one of my formative experi-ences in microfinance visiting a group of women inKenya. After three successive failures of the rains theywere on the verge of starvation (so much so that theyhad to apologise for falling asleep in an afternoonmeeting, explaining that they had not eaten that day).Despite their desperate situation they still managed tomake a full repayment on their loans... they hadclubbed together and sold a chicken to raise money.There has been huge progress in understanding theneeds of different client markets and developing arange of products that respond to client needs.Increasing emphasis on savings and the developmentof micro-insurance build client resilience to prob-lems and provide the means to respond to problems.However, many credit-led MFIs offer little flexibility,locking clients into a rigid system of regular loan


repayments. Credit programmes that apply zero tol-erance with little flexibility risk harming their clients.Most MFIs see delinquency management as beingcritical to success, and send out a strong message tostaff that late payment should not be tolerated. Thisis supported by incentive schemes that often drasti-cally cut financial incentives should the portfolio atrisk rise above quite a low level. In the worst cases wesee MFIs that achieve a 100 percent repayment ratethrough practices such as holding clients ‘hostage’until all money has been collected – clients withrepayment problems leave the meeting to ‘find’ themoney and return after an hour or so. Where doesthe money come from? Perhaps from savings orfrom a friend, but more likely a money lender orselling assets. But organisational incentives do notask this question, and just focus on whether themoney is repaid rather than how it is repaid.The issue is one of balance. I am not arguing thatorganisations should not emphasise repayment,rather that MFIs should understand this tension,and work to maximize their ability to be able torespond to problems that poor clients inevitablyface, and structure products that are responsive todifferent cash flows and that promote savings aswell as credit. To balance their social and financialperformance MFIs need to combine appropriateservices with an ability to be flexible and responsiveto the problems that clients face whilst maintaininghigh repayment rates and a low portfolio at risk.

B E Y O N D A C C E S S – A D D I N G V A L U E T O

M I C R O F I N A N C E S E R V I C E S

Beyond doing no harm, microfinance seeks to havepositive social impact – to add value. As a socialbusiness an MFI can focus not just at how to increaseefficiency and financial returns, but how to increaseeffectiveness and social returns. Value can be addedin a number of ways: by developing financial that aretailored to client needs; through delivery mecha-nisms that are cost-saving for clients (eg. doorstepservices) or that build capacity or empowering (eg.working through groups or through the staff-clientrelationship); non-financial services can be integrat-ed with financial services (eg. business advice, educa-tion or legal support); the infra-structure of microfi-nance can be used to deliver other services to micro-finance clients through partnerships with otherorganisations that specialise in such services. It sounds like stating the obvious, but not all micro-finance is the same. Listening to the debates ragingabout the ‘impact of microfinance’ it would seemthat this point needs to be heard. We have differentmethodologies, products, different target clients,different management systems, and these lead todifferent outcomes. So when we look at microfi-nance, surely we should be looking beyond num-bers of people accessing financial services?

For example, in the push for efficiency the value-added through human relationships is often overlooked. The relationship between client and staff isimportant not just in terms of making a goodassessment as to the clients’ needs and eligibility forservices, but can be at the heart of the ability ofmicrofinance to do far more than provide access tofinancial services and build the capacity and self-esteem of its clients. But the main drivers of growthin the microfinance industry today are efficiencyrather than quality or social value-added. Manage-ment drives up targets for field staff, pares down themethodology to reduce ‘wasteful’ contact timebetween field staff and clients for example to elimi-nating home visits or moving from weekly tomonthly group meetings, centralises services intobranch offices, and introduces technology thatpotentially can all but eliminate the need for anyhuman contact between the MFI and clients. This focus on efficiency, cutting costs and reduc-ing the human interface combined with incentivesthat push growth in numbers risks underminingthe very foundations of effective microfinance. The vision of microfinance is ‘doing well by doinggood’. As the microfinance industry attracts greaterinvestment and achieves increasing commercial suc-cess, there is much debate as to whether microfi-nance is achieving this ‘win-win’ balance, orwhether commercial focus is compromising thesocial mission. Whilst the economic crisis bringschallenges for the clients of microfinance and MFIs,it also creates an opportunity for reflection. This isa time to take stock and ensure that microfinancesets an example for responsible lending that pro-vides access to financial services for the billions ofpeople excluded, and adds value to this access tohelp improve the lives of its clients. We need to recognise that at its heart, microfi-nance is a social business, and that our perfor-mance metrics and management systems need tobalance both social and financial goals. This articlelooks behind the numbers and discusses ways inwhich microfinance can continue to grow whilstmaintaining quality, avoiding harming its clients,and take advantage of opportunities to add valueand maximize the social returns to microfinance.We must measure and manage what we value. ©

—————1 The Microcredit Summit Campaign reported a growth

from 19 million microfinance borrowers in 2000 to 155 millionin 2007, with a growth from 1567 to 3552 MFIs reporting.

2 Data on the Microfinance Information Exchange,www.themix.org

3 Presentation by Xavier Reille, CGAP, at the EuropeanMicrofinance Platform conference, November 2009.

4 Centre for the Study of Financial Innovation.5 See the SMART campaign for client protection

www.smartcampaign.org.

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Professor Malcolm Harper is Chair-man of Micro-Credit Ratings Inter-national Ltd (M-CRIL), EmeritusProfessor, Cranfield School of Man-agement, United Kingdom.Dr Harper is a veteran in the field ofmicroenterprises and microfinance,financial inclusion, and livelihoodspromotion. His core areas of expertiseinclude: microenterprise promotion,assessment of microfinance pro-grammes, designing and developingmicrofinance and microenterprisepromotion programmes and financialanalysis. Prof Harper has advised onand evaluated a large number ofsuch microenterprise programmesand microfinance institutions world-wide. He has substantial experienceof leading multidisciplinary designteams in large and complex microfi-nance and financial inclusion pro-grammes in the poorest regions of theworld. He has worked with mostinternational donors and governmentsand has experience of facilitating donors and private sectorto work on enterprise and microfinance issues. Mr Harper’sresearch and consultancy work has been supported by a widerange of national, international and non-government devel-opment agencies.

T H E C O M P A R T A M O S I P O : T R I U M P H

O R T R A G E D Y ?

N AP R I L T W E N T I E T H 2007, M I C RO F I N A N C E C A M E ofage. Compartamos, a medium sized Mexi-can microfinance bank with some 750,000clients, had its initial public offering on

the stock exchange. About one third of the shareswere put on the market, and the institutions andindividuals which were selling them cleared some450 million dollars, valuing the whole institutionat around one and a half billion dollars. Twoyoung men had started the institution seventeenyears before, with assistance from the UnitedStates Agency for International Development andother agencies. They had adopted the followingmission statement:

“We are a social company committed to the people. Wegenerate development opportunities within the lowereconomic segments, based on innovative and efficientmodels on a wide scale as well as transcending valuesthat create external and internal culture, fulfiling per-manent trusting relationships and contributing to a

better world.” They each made over fifty mil-lion dollars from the flotation,and the rate of return on thesix million dollars which theyand others had earlier investedin the institution was around100% per year. Compartamoswas charging an annual inter-est rate of about 96% on itsmainly very small loans toMexican women, who had pre-viously had no access to creditfrom formal financial institu-tions. There was a certainamount of competition fromother institutions, but Com-partamos had successfullymaintained this high rate ofinterest in order to accumulateprofits to finance its growth,and to attract equity share-holders as a basis for furtherborrowings from banks.

The extraordinarily high valuation was in part theresult of global stock market euphoria, and theattractions of a new form of investment, with per-ceived social as well as profitable gains. Betweenthe flotation and July 2010 the Dow Jones indexfell by around 20%; in the same period the Com-partamos share price had risen by about 30%. Ithad not, however, been a bad investment by thestandards of stock market performance during thatrather turbulent period.The Compartamos IPO has been widely docu-mented elsewhere, and there is still a fierce debateas to whether it was an unfortunate and isolatedexample of excessive profiteering, or a triumphantvindication of the argument that the poor were ascredit-worthy customers as anyone else. My pur-pose, however, is to suggest that this incident wasno more than a rather dramatic illustration of theexploitative everyday reality of microfinance, andthat it is an indicator that that this aspect is rapidlytaking over from the more benign face which themovement once had.


“ He gives

the poor man

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much good

who

gives quickly. ”PP UU BB LL II UU SS SS YY RR UU SS

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M I C R O F I N A N C EA N D T H E P R E S E R V A T I O N O F P O V E R T Y

M A L C O M H A R P E R

The trends which I shall identify are not, I hope,irreversible, and I do not want to suggest thatmicrofinance has been wholly taken over byexploitative interests. Microfinance has brought for-mal financial services to many millions of disadvan-taged households which previously had no access tosuch services. It continues to expand, and to bringthese services to ever more people, for good and forill. I would not suggest that the damaging anddependency-creating features of microfinance,which are the subject of this paper, are the result ofa conspiracy to keep the poor poor, even thoughthis does maintain the customer base of the institu-tions. They are an unfortunate by-product of theway the movement has evolved, which follows thenormal but now accelerated centralising effect ofglobal capitalism. They can, however, be resisted.This short paper will point out some of the waysby which microfinance may be contributing to theperpetuation of poverty, rather than to its allevia-tion (or even to its elimination, as some of itsmore enthusiastic proponents claim that it cando). And, it will suggest ways in which thesetrends may be resisted, or even reversed.These tendencies are covered under the followingfive broad headings:~ the types of clients reached by microfinance;~ the features of the financial products that are

provided; ~ the means through which they are delivered;~ the cost and the uses of micro-loans;~ the sources of funds and ownership of the

microfinance institutions.

C L I E N T S

One of the defining features of microfinance,which has caught the imagination of the generalpublic more than any other, is that its clients, whotoday number is well over one hundred millionpeople, are overwhelmingly women. Microfinanceis not at all a women’s business in the sense that thefounders, owners or staff of the institutions arewomen; they are predominantly male, as are theleaders, owners and staff of most businesses, partic-ularly in poorer countries, but their customers aremainly women. The Micro-credit Summit Cam-paign estimates that 84% of all microfinance clientsare women, and Grameen Bank states that 97% ofits customers, or ‘members’, are women. Manyinstitutions, indeed, refuse even to accept maleclients, although it is unlikely that many apply.This strong gender bias is widely publicised as oneof the main strengths of microfinance, in that itputs financial resources into the hands of womenwho have traditionally been deprived of influenceover the use or even of legal ownership of moneyor other assets, world-wide. This form of discrimi-nation is still strong, even in the so-called devel-oped countries, and is even stronger in poorer

societies. Microfinance has been widely and rea-sonably applauded as an important reversal of thisalmost universal aspect of society, everywhere,since it ‘empowers’ women in the most direct pos-sible way, by putting money into their hands.It is important, however, to examine all the reasonswhy women are the preferred clients for microfi-nance. The intention is to empower women, toenable them to play an equal role in economicdecision-making, and this is right and proper.Women clients, however, play an important partin enabling microfinance institutions to achieveboth aspects of the ‘double bottom line’, to do wellas well as to do good. There are many reasons whythey are more profitable customers than men:Women are physically, economically and sociallyweaker than men; they find it more difficult toresist pressure for repayment, they have feweralternative sources of financial services than menand are thus less likely to risk damage to theircredit rating with the only institution that willserve them, and they are less likely to have power-ful social and political networks which will helpthem to avoid repayment obligations.Additionally, women are more likely than men toaccept routine standardised conditions of borrow-ing, and repayment. They have less opportunitiesto break away from the traditional activities andconstraints of their local communities, and childbearing and child rearing, as well as the ‘householdduties’ which are traditionally ascribed to them,make it less likely that they will be able or wish toinvest in different types of activities, to borrowlarger sums, or repay over longer or more irregularperiods, than their peers. They fit more closely to astandard predictable pattern of customer behav-iour, and this makes them less expensive and lessrisky to serve. They are better business.This may be regarded as exploitation of women’sdisadvantaged condition, or as natural business sense,depending on the viewpoint of the observer, but thepredominance of women as microfinance customersis not only an expression of micro-financiers’ concernto redress social injustice. For whatever reasons, theoperating methods of the industry have evolved insuch a way that it is good business to work mainlywith women.Women are generally poorer than men, so thatworking predominantly with women presumablylowers the income profile of microfinance clients.It is now generally accepted by most well-informedauthorities, however, that microfinance does notreach the very poorest people, the so-called ‘poor-est of the poor’, and that when it does, it oftendoes them more harm than good 1.Many microfinance institutions, such as BRAC inBangladesh, recognise this and have introduced awhole range of remarkable programmes which arespecifically designed to reach out to destitute people.


These programmes, however, are not microfinance;they are poverty alleviation programmes. They mayinvolve grants, in kind or in cash, or they may bebased on paying poor people for their labour on civilworks. They are not ‘sustainable’, still less profitable,and they must be heavily subsidised. Some are highlysuccessful, and have enabled many thousands ofwomen and men to escape from extreme poverty andto join the ranks of the ‘economically active poor’,the main clientele of microfinance.The rhetoric of many other institutions, however,particularly but not only some of those in theGrameen ‘family’, suggests otherwise. Microfinanceis still said to reach and benefit the poorest people,and, it is still widelytouted as a panaceafor poverty. TheGrameen Bank hasitself introduced aprogramme for beg-gars, with very smallno-interest loanswith flexible repay-ment, to enablethem to add micro-vending to their tra-ditional beggingactivity, but this isunique. Microfi-nance generally doesof course reachmany very poor people, if not the very poorest, butthe claim that it reaches ‘the poorest of the poor’,and can on its own eliminate poverty, contributes towhat is perhaps the major problem affecting micro-finance: gross exaggeration of what it can achieve.This in turn leads both ‘social’ and for-profitinvestors, as well as donors, politicians such as thePresident of the United States, and the general pub-lic, to believe that if they or their governments sup-port microfinance they are addressing the root caus-es of extreme poverty. This is obviously an attractiveproposition, since microfinance is popular in theCity of London and on Wall Street as well as inMexico and India. It amounts to an ‘easy way out’the belief that poverty can be alleviated painlessly,and even profitably. This can only ‘crowd’ out’ gen-uine attempts to deal with absolute poverty.A great deal has been written about the peoplewho are and continue to be clients for microfi-nance, and the literature is replete with heart-warming stories about women who have success-fully started little businesses and sent their chil-dren to school. Less is known, however, about thepeople who are not clients, and about those whowere, but have ‘dropped out’. Microfinance is saidto ‘reach the unreached’, but it can also furthermarginalize those most in need.Many institutions do not know or are reluctant toreveal the numbers who drop-out from their groups,

but in East Africa they are said to amount tobetween 25% and as much as 60% per year2 while fig-ures from India show an annual dropout rate ofsome 10% from self-help groups3. There is sadly littleevidence to suggest that the people who drop outfrom microfinance groups are ‘flying out’, becausethey have graduated to an economic level where theywant, and can access, a more individualised type offinancial service, such as the readers of this paper,and the managers and staff of MFIs themselves enjoy.Grameen Bank, again, has introduced student loansto enable young men and women from client fami-lies to go on to higher education, but this is not acommon practice; most microfinance clients either

remain as microfi-nance clients, ordrop out becausethey fall below themodest level of well-being that is neededto remain a groupmember in goodstanding.Some may leavebecause they leavethe area, or becausethey change to acompeting supplierof microfinancialservices, but mostdrop out, because

they cannot maintain the regular savings, they can-not repay their loans or they lack the skills, theconfidence and the opportunities they would needto invest in their own micro-business. The ‘sustain-ability’, or profits, of microfinance institutionsdepend on all their clients being in debt. Someallow clients to remain in their groups while they‘rest’ for a few weeks at most between loan cycles,but if they stop borrowing for any longer they are‘balanced out’, that is, their outstanding loans areset against their accumulated savings, they aregiven the balance, often without any interest, andthey have to leave. Clients who want only to saveare unprofitable, and such people tend to be thepoorest; they are too poor for micro-debt.In my own experience I have found that membersof the groups themselves also want to avoid thetopic of dropouts; those who have dropped out areof course unhappy to talk about their own failure,which has pushed them still further to the marginsof their communities.

F I N A N C I A L P R O D U C T S

Traditional retail banking, worldwide, has beenbased on clients’ savings. These savings are used notmainly as a form of security for loans, or to developand test client’s ability to take small regular amountsfrom their day-to-day spending as ‘practice’ for


repaying a loan. Secure, accessible and if possibleremunerative savings, for their own sake, are themost important service which the institutions offerto their members. Loans come second, and arefunded from the accumulated savings of those whowant mainly to save.Institutions of this type depend on the trust oftheir clients for their survival. They may or maynot be owned in a legal sense by them, but theinstitutions depend on the clients, rather than theclients depending on the institutions. Microfinanceinstitutions, which started by being called micro-credit institutions and still offer loans as their mainproduct, depend on their clients to borrow andrepay their loans, but the dependencyrelationship is heavily weighted infavour of the institution and itsowners. The clients are boundto repay by legal and socialsanctions, and the groupsystems strongly motivatecontinued indebtedness.Savings constitute inde-pendence, loans createdependence. The size and terms ofmicrofinance loans furtherstrengthen the dependenceof their clients. Loans aresmall, and for short terms, withfrequent repayments, commonlyspread over twelve months or less.Clients must remain in continuous contactwith the institution, and the size, and the cost andterms of their loans mean that it is very difficult forthem ever to become independent of their source ofmicrofinance services. Their economic and evensocial survival comes to depend on remaining in thegroup and always being able to borrow and be indebt. There is no escape, except to fall to an evenlower level.

D E L I V E R Y C H A N N E L S

Most microfinance clients receive their financialservices through some kind of group intermedia-tion. The groups may, like self-help groups in India,act as financial intermediaries themselves, borrow-ing from a bank or MFI, or taking members’ savingsand on-lending themselves, or they may perform asocial intermediation role, approving and guaran-teeing members’ loans, and facilitating transactionsbetween members and the institution, but not actu-ally taking title to the funds themselves.These groups perform a valuable service to theirmembers, under the broad heading of ‘empower-ment’. The services they provide to the microfi-nance institution, including guaranteeing or secur-ing members’ loans as well as extensive transactionassistance, are one important means which makes it

possible to provide formal financial services to peo-ple who lack any collateral security and whosefinancial needs are not sufficient to justify the totalcost of an individual account. Microfinance institu-tions outsource to their groups many of the normalfunctions performed by bankers: this assistance isunremunerated, but it can be reasonably be arguedthat it is the only way through which the institu-tion can provide services to the members at all.Group lending systems, however, can containinherent contradictions. They do enable lenders toreduce their costs, and the financial services whichare provided can be empowering for individualborrowers. But the processes of enforcing loan

repayment in particular can be dis-empowering, particularly for the

most poor and vulnerable.Group based systems, through

their informal financial andrisk sharing mechanisms,can reduce informationasymmetries and securehigh recoveries. Theseadvantages, however, areoften offset by theunequal and dependent

power relations whichsuch systems support. By

building on existing informalmechanisms, microfinance

institutions may be perpetuatingand even reinforcing power asymme-

tries in a way that is completely contraryto their stated objectives of poverty alleviation andproviding opportunities for the poorest and mostvulnerable 4.Like many other features of microfinance whichhave been introduced for good reasons, however,groups also have their downsides from the day-to-day point of view of their clients. It is unlikely thatanyone who is reading this paper would be interest-ed in a financial service which demanded atten-dance at a meeting for an hour or more every week,as well as open discussion of all their household’sfinancial affairs, or where they were required toguarantee loans to other customers. Group microfi-nance is a second rate product, which is justifiedbecause the customers are poor. In addition to the risk of loss and the burdensplaced on members’ time and their privacy, groupsalso have a number of other less obvious but poten-tially worrisome effects, which can contribute fur-ther to client dependence. Most businesses, partic-ularly those which have the potential to grow andemploy people in addition to their founders, arestarted by one person, or sometimes by a smallteam. There are of course many successful co-oper-ative businesses, and other enterprises started,owned and managed by larger groups or evenwhole communities, but these are exceptional.

S P A N D A J O U R N A L I , 2 /2 0 1 0 | m i c r o f i n a n c e | 1 0

Entrepreneurship is primarily an individual phe-nomenon.Group microfinance is successful because all themembers of a given group, indeed of all the groupsserviced by a given institution, have approximatelysimilar financial needs. If one person wants to savelarger but less regular sums than her peers, or toborrow for very different periods, it is difficult forthe system to accommodate her needs. Groups canempower their members to demand and receivemore than they could expect as individuals, butthey also reduce all their members to the lowestcommon denominator: all can advance, but only atthe pace of the slower. The slowest and least success-ful members may of course be forced todrop out, but those who remain willstill have to act more or less inconcert, in order to avoid theimbalances which willinevitably occur if one or asmall number of membershave much larger savingsor loan balances thantheir peers. This need not be a prob-lem if microfinance insti-tutions try to help theirmore ambitious clients to‘graduate’ to individualaccounts with a regular bank.Such altruism might be good forlocal economic development, but it isnot good business for any institution toassist its best customers to close their accounts andtake their business elsewhere. It makes sense toretain them, to maximize the profits to be madefrom their business, but not to distort the wholebusiness model on their behalf.Groups are also grateful, whereas individuals all toooften turn and bite the hand that fed them. NGOsand other institutions which want to help the poorthrive on gratitude; it helps to raise more moneyfrom supporters, it reinforces their confidence inthe merit of what they are trying to do, and if theinstitution’s sponsors have political connections,client gratitude can be turned into votes.Women work better in groups than men. Thosemicrofinance institutions which admit men invari-ably find that male groups’ repayment records areworse than women’s. Men’s relative inability to workeffectively in groups may in part be because they arephysically stronger and more able to resist grouppressure, such as for repayment. Whatever may bethe reasons for it, however, group delivery methodsreinforce the predominance of women as microfi-nance clients. As we have seen, this has valuablesocial and business benefits, but it also reinforcesthe unequal power relations between microfinanceinstitutions and their members.

T H E C O S T A N D T H E U S E S O F L O A N S

The cost of microfinance loans further strengthensclients’ dependence. Microfinance interest rates arerarely as high as that charged by Compartamos, butthe average annual yields on the loan portfolio are inthe region of 30%. Such high rates are of little signifi-cance for an investment such as one dollar for apacket of ten cigarettes which will be sold for fifteencents each, or a total of one and a half dollars, in halfa day or less, or even for a hundred dollars worth ofgoods which will be sold in a week days for a profitof perhaps twenty dollars. It is possible to earnreturns such as these, of fifty per cent a day, or twenty

per cent a week, on petty trade, often by sellingbranded products from multinational

companies. The nexus of depen-dence is neatly preserved.

More ‘productive’ enterpris-es, however, such as grow-ing crops on a small farmor manufacturing simpleitems in a village work-shop, require largerinvestments, they earnmuch lower rates of

return, often around thir-ty per cent per year or less,

and they may take half a yearor more to realise their profits 5.

It is unprofitable to finance suchventures with microfinance loans, and

this further marginalizes the borrowers, keep-ing them and the regions and countries fromwhich they come in a state of continuing depen-dence, both on microdebt, and on foreign sourcesfor goods to sell. The returns to capital from mar-keting branded consumer goods and from microfi-nance are generous, and the microfinance clientremains dependent on whatever value she can addby her labour alone. Most microfinance borrowers improve their financialposition through their loans. They may, at the mostelementary level, replace a moneylender loan whichthat cost perhaps ten per cent a month (similar as ithappens to the rate charged by Compartamos) witha microfinance loan costing three per cent a month.The gain of seven per cent a month, even on a loanas small as one hundred dollars, is very significantfor a household whose total earnings may be as lowas two dollars a day or even less. The switch mayinvolve some intangible gains, and losses. Somemoneylenders demand free labour as well as interest,and their loans may be informally linked to thepreservation of traditional repressive hierarchies.Many poor families, on the other hand, also rely ontheir local moneylender for urgent needs, such as animmediate loan to cover the cost of emergency med-ical care. Microfinance institutions cannot usually


match immediate services of this kind, and manyclients prefer to keep their informal credit lines openat the same time as they obtain access to formalfinancial services for the first time.Refinancing a moneylender loan usually involvesno new skills; apart from the intangible aspectsmentioned above, there is usually a straight gain.Similarly, relatively low cost micro-debt for whatare oddly called ‘consumption’ purposes such asschool fees, medical care, or house repairs (asopposed to somehow more worthy ‘productive’investments in stocks of goods for resale for pettytrade, such as bottles of Coca-Cola or sachets ofSunsilk shampoo), can offers an immediate savingover the higher interest rate that might otherwisehave been paid to an informal moneylender.Microfinance is associated with self-employment,and although many loans are used mainly for ‘con-sumption’ (as above) most institutions expect theirclients to invest their loans in micro-enterpriseswhich can be expected to yield a high monetaryreturn and thus to cover the interest charged onthe loan, as well as to generate enough surplus indue course to pay off the principal. The rhetoric ofmicrofinance is about promoting enterprise,empowering the poor to help themselves, ‘a hand-up and not a handout’.As we have seen, however, the scale and cost andterms of micro-loans makes them unsuitable forinvestment in anything but the smallest petty trad-ing businesses, vending, small-scale service busi-nesses and so on. This would not be too serious ifthere were alternative sources of finance that weremore suitable for longer-term investments in job-creating businesses such as manufacturing or farm-ing. In too many places, however, microfinancehas become the dominant paradigm. The long-established commercial banks have often beendrastically ‘down-sized’, privatized or closed, andthe institutional space which they occupied hasbeen taken over by microfinance institutions, suchas the National Microfinance bank in Tanzania orCentenary Bank in Uganda. Similarly, in some parts of the ex-Communist statesof Eastern Europe and Central Asia, where there isno recent history of full-service commercial bank-ing, the dominant banking approach is now micro-banking. These new institutions have been vigor-ously promoted by Western donors, with the resultthat long-established community or state-ownedindustries, or their privately owned successors, havebeen unable to access the type of banking servicesthat they need to run their businesses. Wholeeconomies are moving towards becoming micro-trading economies, dependent for finance on high-ly profitable microfinance institutions owned byWestern European, American or Japanese interests,and similarly dependent on profitable multi-national consumer goods, plantation and resource

companies for the goods which they trade. These‘emerging economies’ risk becoming economicsatellites of the West, in the same way as they usedto be political satellites of the East.

S O U R C E S O F F U N D S A N D O W N E R S H I P .

There are about eighty specialised funds seeking toinvest in the equity of microfinance institutions. Veryfew are based in what might be called ‘destinationcountries’, where there is a major need for microfi-nance. The majority are in wealthier countries, andthe bulk of the invested funds come from theNetherlands, Germany and the United States.These funds haveinvested several billion dollars inthe shares of microfinance institutions. Foreignshareholders control a significant proportion of theworld’s microfinance institutions, and this propor-tion is probably increasing.We live in a globalised world, but it neverthelessseems odd that there should be so much foreigninterest in the ownership of microfinance institu-tions, which are not usually very large, and arequintessentially local in their clientele and theirstaffing. Many of the investors, including some ofthe largest ones, are of course social investors, whoexpect ‘reasonable’ economic returns from theirinvestments as well as social returns. These investorsare now being joined and to an extent supplanted,however, by institutions such as venture funds andthe large multinational commercial banks which aremore concerned with profit than society, particular-ly when profits are becoming harder to earn in theirtraditional markets.There are very good commercial reasons why interna-tional capital is being drawn to microfinance. Theinstitutions are generally not large, but they are grow-ing very fast, and they offer high rates of return, withlimited risks, at a time when such investments are inshort supply. Commercial banks which deal withretail and corporate customers in the ‘developed’world usually expect to earn a net return on theirtotal assets of between one and two per cent; thereturns from microfinance are much higher.As one specialised fund management companyputs it in an advertisement: BlueOrchard’s proven track record has convinced anever-growing number of investors to choose the qualityand profitability of a win-win investment : they earna stable and competitive financial return on theirinvestments while delivering effective social impact inemerging markets by encouraging entrepreneurship atthe micro level.And Accion, one of the pioneers in the promotionand financing of microfinance, organises regularinvestment road shows in New York, London, andother financial centres, under the label Microfi-nance cracking the capital markets.


Multinational banks, such as ABN-AMRO, HSBC andCitibank and others, lend large sums to microfi-nance institutions, sometimes in response to govern-ment or social pressure to be seen to being con-cerned for the poor. Such loans have so far proved tobe good business, as well as good public relations,and commercial debt of this kind has substantiallysupplanted clients’ own savings as a source offinance. In 1998, the institutions listed in the ‘Mix-market’ had about seventeen dollars of client savingsfor every ten dollars of commercial bank loans. By2010 this figure had gone down to less than a third ofthis amount (Mixmarket, ibid.). The institutions notunnaturally found it more profitable to borrow largesums at low cost from commercial sources than toincur the high transaction costs associated with pro-viding on demand pass book savings accounts atmultiple locations. Clients who are in perpetual debtare more profitable than those with their own sav-ings, for microfinance institutions as well as forinformal moneylenders.Community-owned financial institutions generallyrely on their members’ savings as their main sourceof funds. This is partly because they may not havethe financial strength to justify borrowing frombanks, particularly in the early stages of their exis-tence before they have built up share capital frommembers’ contributions. It also, however, reflectstheir members’ priorities: more people need to save,more, and more often, than need to borrow. Thebalance between the savings and the loans portfoliosof retail banks, such as Bank Rakhyat Indonesia,reflect this reality. Most microfinance institutionsstart as NGOs or as non-bank finance companies,and are therefore, quite rightly, not permitted tomobilise demand deposits from the public. They,and their multinational capital supporters, haveappreciated that it is more profitable to continue tofocus on providing debt, and to treat savings prod-ucts as a qualification or security for loans, not as aservice to their customers in its own right.Only a small number of the institutions listed bythe MicroBanking Bulletin are community owned.This is to be expected, since such institutions offerno opportunities for equity shareholdings, andthey have less need for bulk debt, since they canrely on their members’ savings balances. They mayserve their members’ interest better than theircommercially driven competitors, but, as with co-operative retail shops, co-operative farms and everyother type of community enterprise, the tide isrunning against them.

A T E N T A T I V E N E O - M A R X I S T D I A G N O S I S

Marx proposed that modern society is based on acapitalist mode of production, whereby those whohave control over capital can dominate and exploitthose who have to sell their labour to those whocontrol the means of production, through theircapital. He came to this view in the context of

large manufacturing industries, owned by capital-ists and employing vast numbers of workers. Hebelieved that these workers would in time unite tothrow off the yoke of capital, and would usher in anew form of society which was ruled by labour.This belief was not unreasonable, and modern labourmovements, which have done so much to improvethe conditions of workers, have indeed had their ori-gins in factories where large numbers of workers haveto be assembled together in order to use capital effi-ciently. They have to work together, but they can alsoprotest, strike or even rebel together.Microfinance offers a more subtle and potentiallymore durable means whereby those who controlcapital can exploit those who have only their labourto sell. The means of production is no longermachines which require many workers to cometogether to operate them, and possibly also to uniteagainst their employer. Microfinanciers can nowprovide capital, in the form of microcredit, whichborrowers use to purchase the tiny amounts ofstocks or simple tools, which they need to runmicro-enterprises. The surplus they can earn isbarely sufficient for survival, but because theinvestments are so small the borrowers can affordto pay very high rates of interest on their loans.Capitalists no longer have to organise and managelabour. They can extract a higher return on theircapital not by directly employing people, but byfinancing their petty businesses under the guise ofassisting them to become ‘entrepreneurs’. Betterstill, these entrepreneurs will compete against oneanother rather than combining against capital.A large proportion of the merchandise and toolswhich are used by these micro-entrepreneurs ismade in factories which maintain the mode of pro-duction with which Marx was familiar, so that areturn can be earned from both manufacturing andfrom money-lending. The micro-entrepreneurs aremainly women, which leaves their husbands free tomigrate to other places within and outside theirown countries to work in factories or service indus-tries that must be located near to their customers.The Compartamos story with which we startedseems to bear this out.Compartamos’ capital is mainly owned by investorsin the United States, or by their fellow-elites in Mex-ico. They have already benefited hugely from thesuccess of the institution, and they presumably aimto benefit more in the future. Compartamos chargesinterest rates of nearly one hundred per cent, andmost of its clients are women, many of whose hus-bands are working for relatively low wages north ofthe Rio Grande, also in the United States. The small loans from Compartamos enable thesewomen to finance micro-businesses, often peddlingconsumer goods produced and marketed by multi-national companies based in the United States. Theamounts, the terms and the interest rates of theloans are such as to make ‘productive’ farming ormanufacturing investments much less attractive, so


the borrowers’ husbands have to remain away fromhome, working for businesses whose owners haveaccess to more flexible sources of finance.The women may enjoy the ritualised ceremonies ofthe weekly client meetings, as some distraction fromthe grind of their everyday existence, and their pettybusinesses can earn them enough to keep themselvesand their children during the periods between thearrival of remittances from the North. These remit-tances are most likely sent at high cost through USA-based agencies such as Western Union, or throughless costly but more risky informal intermediaries,and Compartamos itself provides an internationalremittance service to its clients, to add to the insur-ance and other products which customers areencouraged to purchase6.Marx’s proposed solution to the problem of socialinjustice has not worked well in practice; his diag-nosis, however, seems to have stood the test of time.

R E M E D I E S

The main purpose of this paper is to promote self-questioning and to provoke discussion. It is easy toidentify feasible remedies to most of the problemsthat have been identified, but it is more difficult toidentify who will carry them out. It is unlikely thatprospective investors, or fund managers, will wantto promote community-owned institutions, or thatmicrofinance managers will willingly hand overtheir best customers to their competitors, or empha-sise client savings as a source of funds when theyknow that bulk loans from commercial banks areless expensive and less trouble.I shall nevertheless conclude with a short list ofchanges which can ‘make a difference’, in the hopethat some readers who are in a position to imple-ment them will do so, even when this may reduceprofitability or require subsidy.

C L I E N T S

~ Microfinance institutions should attempt toredress the gender imbalance in their client pro-file, by including more men, and when neces-sary adapting existing products and deliverymethods to suit male customers better;

~ the institutions should carefully monitor thosewho drop out from their groups, and shouldeither themselves attempt to assist such peopleto improve their position or introduce them toother institutions which can offer suitable pro-grammes for them;

~ more ambitious clients should be encouragedand assisted to ‘fly out’ and if necessary to trans-fer to competing institutions which will be ableto serve their needs more effectively.

Products and their delivery:~ flexible, accessible, voluntary and remunerative

savings facilities should be offered to all clients,

irrespective of their need or desire for loans. Ifthe microfinance institution is not itself permit-ted to take demand deposits, arrangementsshould be made to act as agent for an institu-tion that is a regulated savings institution;

~ services should be offered to clients irrespective ofwhether or not they are or profess to intend to beself-employed. Clients should be allowed to usetheir loans as they wish, so long as they can berepaid, and the distinction between ‘consumption’and ‘productive’ purposes should be dropped;

~ clients should be allowed and encouraged toremain on the books of microfinance institutionsirrespective of whether they are borrowing or not;

~ group methods of intermediation should beregarded as a temporary second-rate expedient,from which clients should be encouraged tomove as soon as they can to more dignified andless onerous individual services;

~ the various forms of group intermediation shouldthemselves be treated as complementary steps ona ‘ladder’, not as competitive products. Clientsshould be encouraged to climb from Grameen-type solidarity groups, to self-help groups, tosmaller joint liability groups and thence to indi-vidual accounts, even if this means that they willmove from one institution to another.

F U N D S A N D O W N E R S H I P

~ Client savings should be regarded as the opti-mum main source of funds for microfinanceinstitutions, even if they are more expensive toraise and manage than bulk loans from com-mercial banks or other sources;

~ local rather than foreign equity shareholdersshould be preferred whenever possible;

~ community-owned microfinance institutionsshould be promoted and assisted in preferenceto local private for-profit finance companies orbanks. ©

—————1 See, for instance, Navajas, S. ~ Schreiner, M. ~

Meyer, R. ~ Gonzalez-Vega, C. ~ Rodriguez-Meza, J.,“Microcredit and the Poorest of the Poor: Theory andEvidence from Bolivia”, in World Development, 28(1): 333-346, and Islam, Tazul, Microcredit and Poverty Alleviation,Ashgate: London, 2007.

2 Wright G.A.N., MicroSave Briefing Note No. 8,Dropouts and Graduates: What Do They Mean For MFIs?,Microsave: Nairobi, 2002.

3 Sinha F. et al., Microfinance ‘Self help groups in India:Living up to their Promise?, PA Publishing: Rugby, 2008.

4 Harper, A., Microfinance Peer Lending Groups;Empowering the Poor or Perpetuating Inequality? Unpub-lished MSC thesis, SOAS, London 2000.

5 Dichter, T. ~ Harper, M., What’s wrong with microfi-nance, PAP Rugby and Rawat Jaipur, 2007: 89.

6 Business Week, 13.12.2007.


Jennifer Brinkerhoff is professor ofPublic administration, Internationalbusiness and International affairs.She holds a PhD in Public adminis-tration from the University of South-ern California, and an MA in PublicAdministration from the MontereyInstitute of International Studies.She teaches courses on public service,international development policyand administration, developmentmanagement, and organizationalbehaviour. She consults for multilateral develop-ment banks, bilateral assistance agen-cies, NGOs, and foundations. Com-bining her research with this work,she published Partnership for Inter-national Development: Rhetoric orResults? (Lynne Rienner Publishers,2002), as well as numerous articlesand book chapters on topics rangingfrom evaluation, to NGOs, failedstates, governance, and diasporas. Sheis the author of Digital Diasporas:Identity and Transnational Engagement (Cambridge Uni-versity Press, forthcoming), the editor of Diasporas andDevelopment: Exploring the Potential (Lynne RiennerPublishers, 2008), and the editor of the Lynne Rienner Pub-lishers book series on Diasporas in World Politics. She is theco-Director and co-founder of GW’s Diaspora Research Pro-gram, a multidisciplinary research program on diasporas,identity, policy, and development; and co-founded the GW

International NGO team and co-edited NGOs and the Mil-lennium Development Goals: Citizen Action to ReducePoverty (New York: Palgrave MacMillan, 2007).Dr Brinkerhoff ’s applied work encompasses partnership, civilsociety, institutional development, development management,and training methodologies, and includes work for the Ministryof Foreign Affairs, the Netherlands; and in Africa, China,Mongolia, Central Asia, and Russia for the US Agency forInternational Development and the World Bank.

ESPITE THE THEORETICAL POSSIBILITY, ERADICATING

poverty – or even halving it by 2015 asintended by the first Millennium Develop-ment Goal1 – is a daunting and perhaps

unrealistic endeavour. Since the inception of the

international development industry, systematicefforts have been made to reduce poverty. Withinnation states such efforts have a much longer history.So why, with all of our technology, have we failed toeliminate poverty? The easy answers refer to contex-tual factors, including political will. A more nuanced

response calls attention to theintractability of poverty. Specifi-cally, Smith (2005) calls atten-tion to sixteen poverty traps,which demonstrate the interde-pendence of a range of factorsthat contribute to poverty andprevent its escape. These factorsinclude, among other things,illiteracy and/or low educationand skills levels; lack of access toworking capital, insurance, andinformation; high debt; poorphysical and mental health;high fertility; child labour; thepriority of subsistence; andpowerlessness. The develop-ment industry has developedtargeted approaches to respondto many of these challenges ona case-by-case basis, sometimeswith highly complex assessmentand response tools. So while wemay not be able to eradicate

poverty on a global level, we certainly do know alot about how to maximize the efficiency and effec-tiveness of targeted efforts to do so. Yet a remainingquestion is who does what to address this broadrange of factors?The interdependence of poverty traps and the les-son that addressing only one or a few factors is toooften insufficient for facilitating escape from povertyhave led many development organisations to con-sider how best to acknowledge or include comple-mentary services. Options include: 1) remainingspecialised to maximize organisational efficiencythrough comparative advantage; 2) developingmulti-sectoral organisations and programs; and 3)accessing complementary services through partner-ship with other organisations and programs. Thereare trade-offs to each of these options. This articleexplores options for organisational scope, specificallywith respect to partnership approaches.No one option will be ideal to all contexts. To bestgauge the potential of the partnership option, it isfirst necessary to explore its advantages, as well as


M A X I M I S I N G T H E E F F E C T I V E N E S SOF MICROENTERPRISE DEVELOPMENT: THE PARTNERSHIP OPTION

J E N N I F E R M . B R I N K E R H O F F

D

“ No stranger

to trouble

myself ,

I am learning

to care for

the unhappy. ”VV II RR GG II LL

g | A LT E R N AT I V E S

possible contextual constraints. Building on my pre-vious research (Brinkerhoff, 2002a, 2002b), I will firstdefine partnership, specify its comparative advantagesespecially as they concern available governance mech-anisms, and present potential contextual constraintsto its operationalization. Next, I will describe theexperience of a range of microenterprise develop-ment experiences, as presented by US-based practi-tioners. I will then explore how these experiencescorrespond to our general knowledge of partnershippractice. I conclude with recommendations forwhen the partnership option may be most effectivein combating poverty traps.

M A K I N G T H E C A S E F O R P A R T N E R S H I P

P A R T N E R S H I P D E F I N E D

The potential advantages of partnership are many.The nature and scale of poverty traps are impossi-ble to address in isolation. Partnership can providea means of developing strategic direction and coor-dination in this context, affording a scale and inte-gration of services that is impossible for any actoroperating alone. Without the cooperation of mul-tiple and diverse actors, each with their own per-spective and comparative advantages, we risk treat-ing symptoms rather than causes and becomingfrustrated by systemic forces that preserve the sta-tus quo (Brown and Ashman, 1996).Literature and experience combine to suggest thattwo dimensions are salient for defining partner-ship. Mutuality encompasses the spirit of partner-ship principles; and organisation identity capturesthe rationale for selecting particular partners, andits maintenance is the basis of partnership’s value-added. Mutuality refers to mutual dependence,and entails respective rights and responsibilities ofeach actor to the others (see Kellner and Thackray,1999). These rights and responsibilities seek tomaximize benefits for each party, subject to limitsposed by the expediency of meeting joint objec-tives. Embedded in mutuality is a strong mutualcommitment to partnership goals and objectives,and an assumption that these joint objectives areconsistent and supportive of each partner organisa-tion mission and objectives. Mutuality meanssome degree of equality in decision-making, asopposed to domination of one or more partners.All partners have an opportunity to influence theirshared objectives, processes, outcomes, and evalua-tion. Mutuality can be distinguished as horizontal, asopposed to hierarchical, coordination and account-ability. The ideal-type partnership also includes prin-ciples such as jointly agreed purpose and values;and mutual trust and respect.organisation identity generally refers to that whichis distinctive and enduring in a particular organisa-tion. It is generally believed that the creation andmaintenance of organisation identity is essential tolong term success (see Gioia et al., 2000; see also

Albert and Whetten, 1985). The key is not to main-tain organisation systems, processes, and strategiesover time, but to maintain their core values andconstituencies. Gagliardi (1986) argues that success-ful organisations change in response to turbulentenvironments precisely in order to maintain theiridentity over time.organisation identity can be examined at two levels(Brinkerhoff, 2002a). First, an individual organisa-tion has its own mission, values, and identified con-stituencies to which it is accountable and respon-sive. The maintenance of organisation identity is theextent to which an organisation remains consistentand committed to its mission, core values, and con-stituencies.Second, from a broader institutional view,organisation identity also refers to the maintenance ofcharacteristics – particularly comparative advantages –reflective of the sector or organisational type fromwhich the organisation originates. A primary driverfor partnerships is accessing key resources neededto reach objectives, but lacking or insufficient with-in one actor’s individual reserves. Such assets canentail the hard resources of money and materials, aswell as important soft resources, such as managerialand technical skills, information, contacts, andcredibility/legitimacy.Based on these two dimensions, partnership in prac-tice is identified as a matter of degree. The ideal typewould maximize organisation identity and mutuality,including equality of decision making. Since com-promises to support and respect the identity of onespartners is inevitable, and as exact equality of powerin decision making is unrealistic, partnership is a rel-ative practice. Nevertheless, these dimensions can beused to contrast partnership (high organisation iden-tity, high mutuality) from other types of inter-organ-isationalrelationships, such as contracting (highorganisation identity, low mutuality), extension (loworganisation identity, low mutuality), and cooptationor gradual absorption (low organisation identity, highmutuality) (Brinkerhoff, 2002a).

I N T E R - O R G A N I S A T I O N A L R E L A T I O N S H I P

G O V E R N A N C E M E C H A N I S M S

Governance mechanism refers to the approach andenforceability of rules and associated desired behav-iour. Governance requires recourse in the eventthat rules are broken or expectations are not met.Governance mechanisms include market, bureau-cratic, or culture approaches, or some combinationof all three2. The most effective organisations com-bine these three mechanisms (see, for example, Cos-ton 1998; Peters 1998). At the same time, each has itsadvantages and disadvantages, as well as limits tofeasibility. For example, market mechanisms (e.g.,contracts) are not always possible (a price must bespecifiable) and are, like any market, subject to mar-ket failures. Bureaucratic mechanisms (e.g., rules,regulations, and standard operating procedures) can


be costly to monitor and enforce and often restrictflexibility. And, because they are based on trust,culture mechanisms, are not as easily enforceable.Recourse in the event of their violation is notalways immediate or specifiable.Partnerships, by definition, are not based on hier-archy. Therefore, while they may combine all threegovernance mechanisms, they are likely to relymore heavily on culture mechanisms than othertypes of inter-organisational relationships. Underculture mechanisms enforcement and complianceare based on trust and expectations rooted in a senseof belonging. Culture mechanisms can become the

glue that bonds different actors, ensuring compli-ance not only with expected norms of behaviour,but also maximising the efficiency and effectivenessof other governance mechanisms (Coston 1998).Because they are voluntary, they also are the mostflexible and lowest cost mechanism.

T H E P O T E N T I A L A D V A N T A G E S O F P A R T N E R S H I P

Partnership’s value-added is rooted in its definingdimensions. organisation identity is the impetus forinitiating a partnership strategy. Partnerships withother actors are pursued precisely because theseactors have something unique to offer, whetherresources, skills, relationships, or consent. If organi-sation identity is lost, by definition comparativeadvantages are lost, the organisation loses legitima-cy in the eyes of its defined constituencies, and itseffectiveness wanes. Mutuality can reinforce organi-sation identity. The opportunity to participate andinfluence equally means that each actor can moreeasily protect its organisation identity, and hencethe efficiency, effectiveness, and synergistic rewardsof the partnership. At the outset, no one organisa-tion can understand the implications of its or thepartnership’s actions for members’ organisation

identity. Mutuality at least affords partner organisa-tions the opportunity to consider and explain theseimplications and potentially defend their distinc-tive advantages, skills, and legitimacy – all of whichare necessary for the partnership’s success.Reliance on culture governance mechanisms affordspartnerships a greater degree of flexibility in max-imising the application of comparative advantagesand flexibly responding to environmental con-straints (to be discussed below). organisations andalliances characterised by a strong reliance on cul-ture mechanisms are seen to be organic in theirstructure, as opposed to mechanistic (see Burns and

Stalker 1961). Advantages of organic structuresinclude:~ fluid division of labour based on specialised

knowledge and experience;~ emphasis on application of knowledge to contribute

to organisational effectiveness (i.e., mission);~ continual redefinition and adjustment of indi-

vidual tasks through interaction;~ individual responsibility for contributing to

overall organisation effectiveness;~ commitment to organisation mission;~ knowledge about the organisation technical

nature and effectiveness can be located any-where in the network;

~ fluid interaction, contingent on the informa-tion/skills required in the moment;

~ emphasis in communications on informationand advice (not instructions and decisions);

~ innovation, creative thinking, and knowledge ofinterdependence highly valued; and

~ decisions made through participation (Brinker-hoff, 2002b).


E N V I R O N M E N T A L C O N S T R A I N T S

Environmental factors influence the extent towhich partnership is desirable or feasible. In devel-opment contexts, there are many factors and actorsat play at various levels, each of which affects theothers to greater or lesser degrees. I focus here onthe immediate partnership environment ratherthan the broader context; that is, those features that

directly impact the inputs, processes, and outputsof partnership systems.Drawing on a decade of fieldwork consisting ofcase analysis and expert interviews, I delineate ninekey ‘environmental hostility’ factors – those thatcan inhibit or enhance achievement of mutualityand organisational identity in partnership relationsinvolving NGOs (Brinkerhoff, 2002b). These includefactors related to the actors involved, both individ-uals and organisations; the specific partnershipobjective; stakeholders; and general contextual fea-tures. The nine factors follow:1 ~ Partnership Champions: the possibility ofdynamic, entrepreneurial, and potentially charis-matic personalities with the capacity to championthe partnership effort. The immediate context mayalso present salient drivers to inspire such individ-uals to champion partnership approaches.2 ~ Institutional Linkages: Pre-existence of strongand supportive relationships among partners; part-ners know and understand each other’s missionand track record.3 ~ Characteristics of Partner organisations: organi-sations with identified comparative advantages, req-uisite capacity, strong organisation identity, support-ive stakeholders and constituents, perceived as legiti-mate and trustworthy among constituents, havestrong drivers to participate in the particular partner-ship, share the partnership vision, and have broadsupport within the organisation for the partnership.

~ Partnership Objective: Does not greatly chal-lenge vested interests or implicate a wide numberof government agencies; outcomes will be directlyfelt at the local level and can be readily identified;and there is a ready demand for the good or ser-vice to be produced.~ Partnership Stakeholders: Relatively homoge-

neous, organised, and have influencing capacity.~ Supportive Legal Frameworks: Partnership and

its chosen activities are legal, and legal frameworkis flexible. Partners have discretion in the designand structure of the partnership.~ Stability: There is minimal staff turnover with

the partner organisations, and stakeholder interestsand demands remain relatively stable.~ Flexibility: Partner organisations are flexible in

pursuing new structures and procedures and/ormaking adjustments in existing ones to supportthe partnership and partner organisations’ identity.~ Artificiality3: Low levels of distortion. The part-

nership is characterised by local ownership andmutual agreements and relationships.

The absence of these factors contributes to envi-ronmental hostility. The lack of one or more ofthese factors does not, in itself, prevent effectivepartnership. Rather, it makes it more difficult,and, in some cases, much more costly. They arealso not all of equal importance or malleability.While the characteristics of certain objectivesmight make partnership work very complex andchallenging, the importance of those objectivesand/or their beneficiaries may outweigh these diffi-culties. Some of these contextual features are sub-ject to influence, others are not. The identificationof these factors can inform cost-benefit analyses todetermine the appropriateness of a partnershipapproach. However, the relative valuation of theequation will necessarily be subjective, depending,


in part, on the mission of the initiating organisa-tion and its corresponding operational values.

E X A M P L E S O F M I C R O E N T E R P R I S E

D E V E L O P M E N T : T H E O P T I O N S I N P R A C T I C E

The following vignettes are taken from practitionerremarks at the George Washington University Inter-national NGO Team Roundtable on “The Effective-ness of Multiplex vs. specialised Approaches toMicroenterprise Development” (April 8, 2005).

F I N C A I N T E R N A T I O N A L 4

FINCA is known as the founding organisation forvillage banking. Not only does it provide micro-credit to the poor, “it helps to create community-run, community-focused credit and savings associ-ations, particularly in areas untouched by the formalfinancial industry” (FINCA, 2005). FINCA Internationalis a network of program affiliates in four regions

(Latin America, Africa, Eastern Europe, and CentralAsia). According to 2005 estimates, 60-70% of its2,800 employees worldwide were “children of poverty,”that is, children who, having observed their mothersattending village bank meetings, eventually becamecredit officers. This development highlights a keypriority for FINCA now and into the future: to raiseawareness among microfinance institutions of theneed to reach beyond the borrowing parents toexpand their client bases to include the educatedchildren of these borrowers, making available busi-ness loans and microfranchises. In thinking about using microfinance to alleviatepoverty, Hatch (2005) emphasises the importance ofpartnership with the poor: “If you provide resourcesto the poor, give them the flexibility and the

responsibility for making their own decisions abouthow they’re going to take advantage of thoseopportunities…. They are capable of doing incredi-bly effective, good stuff, in terms of fixing them-selves and their own poverty…. It’s the financialgrease in the wheel of the household that givesthem those options they didn’t have before…. It’salways been my feeling that the ideal integrators are

the poor families. They know what they need. Aslong as they have access to information aboutwhere they can get assistance, they are the ideal,least cost, and best integrator we have.”FINCA has developed an evaluation instrument togauge improvements in the quality of life of theirclients. The ten minute, palm pilot assisted inter-view measures seven indicators, starting withmoney metrics, to assess expenditure patterns inorder to determine if FINCA is reaching the poorestof the poor, and moving to six social metrics: foodsecurity, health, housing, education, empower-ment, and social capital. FINCA plans to use theresults to assess its effectiveness in meeting a doublebottom line for its clients: financial, as well as socialimprovements in quality of life.

S A V E T H E C H I L D R E N 5

Save the Children (Save) is a multi-sectoral organi-sation that operates in approximately fifty coun-tries. Its programs encompass health, HIV/AIDS,education, food security, and economic opportuni-ties, mostly in the form of microfinance. Save’sapproach to microfinance is group-guaranteed lend-ing and savings. In establishing micro-finance insti-tutions (MFIs), Save starts with a very specialisedfocus (i.e., a limited array of services) with an aimto attain operational sustainability. Once that isachieved, the emphasis is on financial sustainability,


and, eventually, institutional independence fromSave. Resulting institutions follow whatever thelocal legal framework allows. Hence the priority forsustainability and independence trumps any consid-eration of offering complementary services. The aimis to make the institution capable of operating with-out any subsidies into the long run.Because of its multi-sectoral nature, Save the Chil-dren has opportunities to consider and even experi-ment with integrated programming. This was thesubject of its 2005 Program Learning Group, anannual event to reflect on Save the Children’s prac-tice and potential paths for innovation and improve-ment. Staff opinions varied and official conclusionswere still pending as of this writing.Conly (2005) summarised the vari-ous viewpoints. First is the perspec-tive that the institutions shouldremain focused on financial services;diversification muddles the objec-tives and can overwhelm staff capac-ity/skills, damaging effectivenessand efficiency. Second, businessdevelopment skills might be appro-priate to integrate, given their natur-al fit with the objectives of the MFIsand the ambitions of their clientele.A final perspective argues for theprovision of social services alongsidemicrofinance. Preliminary conclu-sions support the integration ofthose financial services that maxi-mize complementarity, specificallystrengthening microfinance, withthe caveat that these, too, must befinancially sustainable; some ser-vices can be delivered in coopera-tion with the microfinance services,but should be under the purview ofother providers, or possibly otherdivisions within Save; and these ser-vices should not be required, as they may detractfrom the clients’ economic priorities pertaining totheir microenterprise (e.g., requiring time and atten-tion away from the business).

W O R L D V I S I O N 6

Like Save, World Vision is a multi-sectoral organi-sation, but it operates through specialised pro-grams, taking advantage of complementaritiesacross activities. This is mostly achieved through itsmulti-sectoral area development programs (ADPs),which include health, education, and leadershipdevelopment. In 2005, World Vision introducedbusiness development services related to access tomarket. The MFIs are separate legal entities, thoughthey benefit from the World Vision reputation vis-à-vis donors and other service providers.At the national office, the separate structure of thearea development program staff and related specialists,and the microfinance staff poses opportunities and

challenges for ensuring holistic service provision forcombating poverty traps. ADPs often do pre-enterprisework, targeting the poorest of the poor. As long termprograms (approximately 15 years in each location),the ADPs establish trust through long term relation-ships between local staff and targeted communities.Microfinance programming can capitalise on thistrust perhaps to more quickly initiate and reach sus-tainability of MFIs. On the other hand, the ADPemphasis on the poorest of the poor means that oftentarget areas for development pose the greatest chal-lenges to microenterprise development: poverty,which limits consumption potential; environmentalfeatures, which limit agricultural production poten-

tial; and remoteness, which poseschallenges to market access.Also similar to Save’s programming,World Vision’s microfinance pro-gramming is driven by the “four Ss”:separate, specialised, sustainable(within four years), and of signifi-cant scale. The latter seeks to capi-talise on the time and energyrequired to establish each MFI. Theprovision of services is also demanddriven. Other donors may be avail-able and known to clients for theirspecialisation in other types of ser-vices. In some instances, WorldVision may partner with theseother providers, for example, underlarge HIV/AIDS grants. Complemen-tarity among partners can be eithergeographic or sectoral.Conly (2005) summarises WorldVision’s perspective on the scopequestion with the following: MFIsshould remain specialised; integra-tion of services is most beneficialwhen it concerns business develop-

ment services (e.g., access to markets), and wherethere are already multi-sectoral interventions inspecific geographic zones (i.e., ADPs); and partner-ships should be pursued when large grants are avail-able (e.g., HIV/AIDS, food programming), whereconsortiums can maximize effectiveness.

M I C R O F I N A N C E N E T W O R K 7

The Microfinance Network is a global MFI associa-tion. Membership is diverse, including networksand individual institutions, with different method-ologies, but all are “committed to improving thelives of low-income people through provision ofcredit, savings, and other financial services” (Hattel,2005). The membership represents all three scopeoptions: 1) provision of financial and non-financialservices (an holistic approach); 2) specialised MFIsthat offer only financial services; and 3) specialisedMFIs that build strategic alliances with other spe-cialised institutions in order to provide a broader


range of both financial and non-financial services(approximately 95% of the Network’s membership).The following examples are illustrative.

S H A R E M I C R O F I N L I M I T E D , I N D I A

Share Microfin, a Southern NGO operating in AndhraPradesh is a non-bank financial institution servingwomen in the poorest sectors of the population.Share Microfin provides financial services, as wellas skills training to enable income generation.Share Microfin has achieved a 100% repayment rate.Its operational viability stems from keeping opera-tional costs low and mobilising financial resourcesfrom development and commercialbanks.

P R O D E M F F P , B O L I V I A

PRODEM FFP serves micro, small,and medium businesses. It is thelargest branch network in Bolivia(73 branches as of 2005), with 70% ofthe branches in rural areas, whichalso represents 30% of the loan port-folio. Their clientele represent bothrural and urban areas and a rangeof economic backgrounds. As a reg-ulated financial institution, PRO-DEM FFP offers savings services aswell as loan products. Additionalservices include money transfer andlife insurance.

C O M P A R T A M O S , M E X I C O

Compartamos is a non-bankfinancial institution. Recognisingthe changing needs of clients overtime, Compartamos seeks strategicalliances with other providers to make available arange of services corresponding to their clients’financial needs at different stages of life. For exam-ple, their needs framework begins with a workingcapital loan and moves to house loan, medicalinsurance, education loan, and, finally life insur-ance. The strategic alliances with other providersenable fast growth, a short learning curve, capitali-sation of the expertise of other providers, andproduct improvement (quality and range), at lessexpense to clients, saving staff time and organisa-tion financial resources.

B R A C , B A N G L A D E S H 8

BRAC is a “Credit Plus” model. It seeks to con-tribute to “people’s social, economic, political, andhuman capacity building” (Hattel, 2005). BRACpromotes income generation for the poor throughmicrocredit, health, education, and training pro-grams (e.g., land rights, women’s rights). Its largest

component is microfinance, making it the largestmicrofinance delivery organisation in the world(Ahmed, 2005). As of 2005, BRAC had organised115,840 village organisations, with a total member-ship of almost 4 million, and a loan repaymentrate of 99.19%. In addition, approximately 2.6 mil-lion children had graduated from BRAC schools,with 1.1 million currently enrolled (Hattel, 2005).BRAC evolved in response to listening to the needsof the poor themselves. As a result, BRAC’s pro-gramming is based on the belief that microfinancecannot solve all the problems of poverty; it mustbe accompanied by other interventions in health,education, and empowerment through legal edu-

cation (Ahmed, 2005). BRAC’s pro-grams have generated sustainablyself-financing clientele, leadingBRAC to establish a BRAC Bank toserve this evolving client base.BRAC’s microfinance component isself-financing, with interest cover-ing operational costs. However,programs in health and educationcannot be made self-financing.

P A R T N E R S H I P

F O R M I C R O E N T E R P R I S E

D E V E L O P M E N T

T Y P E S

The vignettes provide a range ofexamples of partnering and thinkingabout partnership for microenter-prise development. First, microen-terprise service providers who aremulti-sectoral organisations mightconsider partnering internally withother programs/divisions of theirorganisation. This approach con-trasts with integration in that the

programs maintain separate staff, funding, andmanagement arrangements and do not representan added cost (and financial sustainability concern)for the microenterprise development program.Save the Children takes this approach, emphasisingthat the cross-sectoral services may be made avail-able through these internal partnership arrange-ments, but they should not be required. WorldVision pursues this approach through its areadevelopment programs.Another type of partnership is that between themicroenterprise development provider and the MFIsthat it creates. World Vision illustrates this approach,where the MFIs become independent but still benefitfrom their association with World Vision, both bycapitalising on the World Vision branding, or repu-tation, and by having access to multi-sectoral ser-vices available through World Vision’s ADPs. WorldVision’s ADPs represent a sequencing of scopeoptions, beginning with multi-sectoral approaches


providing “pre-enterprise” work, extending to spe-cialised services of MFI creation, and yielding part-nerships that enable MFI clientele to access continuingmulti-sectoral services of the ADPs. Third, microenterprise development providers canpartner with other service providers specialising inother sectors and/or complementary services. WorldVision may pursue this approach, for example, whenlarge grants provide incentives and other providerswith geographic or sectoral complementarity exist.Compartamos partners with other providers toensure the delivery of relevant services over the lifestages of its clients. While Share Microfin chooses tointegrate training with microfinance, it partners withdevelopment and commercial banks to mobilisefinancial resources.Providers may also consider expanding services tomeet the needs of extended clients, such as thenext generation of service beneficiaries. For exam-ple, FINCA is looking to extend benefits and finan-cial services to the children of borrowing mothers,whether through employment opportunities, orbusiness loans. In this sense, FINCA becomes partof a growing economic sector with possibilities formeeting diverse needs through a range of servicesand service providers.Finally, a theme especially championed by Hatch(2005), is the notion of partnering with the poorthemselves. Here, the relationship is one of trust,where the service provider trusts that poor peopleknow what is in their best interest; they know thebest way for them to escape poverty traps. FINCA’snew evaluation tool is testing the effectiveness ofthis approach. However, such a partnership orienta-tion requires that the poor have the requisite infor-mation and that other providers of needed servicesexist, which relates to environmental constraints(discussed below). BRAC, on the other hand, is amulti-sectoral organisation providing a range of ser-vices; it partners with the poor in that it does notrequire microfinance clients to also partake of itshealth and education services.

A D V A N T A G E S

Partnership can provide opportunities for 1) strate-gic direction and coordination to meet the interde-pendent needs of poor people; 2) achieving greaterscale and integration of services; 3) addressingthese needs holistically and efficiently, by relyingon the specialised knowledge and expertise of eachactor; and 4) simultaneously maintaining theorganisation identity of specialised program officesand organisations. Partners may share their com-mitment to help the poor escape from poverty, yetremain true to their particular organisation mis-sion and values for doing so, thus maximising thecontribution of each. In other words, efficiencyand effectiveness are not lost by trying to reinvent

staff skills and orientation to suit a broader rangeof service delivery requirements.The vignettes illustrate how partnership approachescan capitalise on comparative sector advantages.National governments provide legal frameworkswith which the creation of MFIs must concur andwhich also support the regulatory framework nec-essary for financial service delivery. The featuredNGOs play an important intermediary and socialmobilisation role vis-à-vis local communities, whetherthrough the establishment of village banking, lendinggroups, or community operated MFIs. They alsoflexibly respond to broad needs of their clientele,whether directly or in partnership with otheractors. Local communities assume ownership andoperation of created MFIs and lending groups. Theprivate sector is investing in and supporting theavailability of financial and technical resources tomicroenterprise development. And donors anddevelopment agencies facilitate multi-sectoral part-nerships and provide financial support, for example,through large grants.Various governance mechanisms are demonstratedin the examples, confirming both the limits andopportunities each presents. Market mechanisms,such as interest rates, enable MFIs to efficientlyoperate and achieve financial sustainability. Con-tracts may also regulate multi-sectoral partner-ships, especially those funded through large grants.Bureaucratic mechanisms, such as standard operat-ing procedures and memoranda of understandingoften regulate internal and external partnerships.They are also used to coordinate service deliveryby multiple providers. Culture mechanisms aremost apparent in the loosely organised partnershipapproaches, in internal and multi-organisationalpartnerships, as well as the partnership with thepoor themselves. Here, trust in each actor’s exper-tise, knowledge of needs, and determinedapproach is the guiding rule, as well as the sharedcommitment to see the poor escape from poverty.World Vision’s ADPs illustrate this key comparativeadvantage of partnership approaches, with theirorganic structures and reliance on cultural gover-nance mechanisms: trust. The trust created bymulti-sectoral pre-enterprise service delivery facili-tates the creation of MFIs. This approach may benecessary given that World Vision’s ADPs targetclientele that are far from the ideal for ensuring MFIsustainability. Trust appears to be less critical, in con-trast, for FFP PRODEM in Bolivia, which concentratesmore heavily on specialisation in financial services tomaximize efficiency and serve a diverse clientele;here, higher income clients sometimes receivinglower cost service delivery (e.g., in urban areas) canensure financial sustainability of high cost services tolower income clients (e.g., in remote areas).Each of the illustrated partnership approaches isorganic in structure. They are not inflexible blueprints


for meeting interdependent needs. The division oflabour is fluid based on the available actors and theirrespective expertise and knowledge – whether theseare internal to the organisation or beyond its bound-aries. A heavy emphasis is placed on “sticking toone’s knitting” in order to ensure effectiveness, effi-ciency, and sustainability. Each actor takes responsi-bility for overall success in meeting the broad needsof the poor. Communications and advice are hori-zontal and geared towards effectiveness, rather thanhierarchical in nature.

I M P L I C A T I O N S O F E N V I R O N M E N T A L

C O N S T R A I N T S

Ironically, one of the key elements necessary forlow environmental hostility for partnerships is theexistence of qualified potential partner organisa-tions. When these organisations are already in exis-tence and accessible to the poor, a partnershipwith the poor becomes possible and formal inter-organisational partnerships across sectors may nolonger be necessary. This finding implies thatinter-organisational partnerships may be mostbeneficial when potential partner organisations arenot already accessible to a particular clientele(whether defined by geographic region or need) orwhen the poor lack information about availableservices or face logistical barriers to accessingthem. In the latter case, the inter-organisationalpartnership might focus on information sharingand coordination to market available services andto address access obstacles specific to microenter-prise development clientele.The potential for partnership with the poor and forinter-organisational partnership is also enhancedwhen there are existing institutional linkages andan understanding of what each partner or servicedeliverer may have to offer. Also assumed is thatthe various actors will share a commitment topoverty reduction without major philosophical dif-ferences as to the means. When this occurs, it ismuch easier to identify partnership champions whoput these shared objectives first in developing coor-dination and information sharing mechanisms. Allof these factors are much less problematic for inter-nally-oriented partnerships.Because the partnership stakeholders may be diverse,the variety of partnership options enables actors toflexibly respond to these needs. This is illustrated byCompartamos whose partner arrangements varyaccording to the life stage of the client being served.In the particular case of microenterprise development,the examples also demonstrate a range of potentialhostility concerning selected objectives and stakehold-ers. For example, World Vision’s microenterprisedevelopment programming follows the lead of theADPs, which select regions whose characteristics aremost hostile to microenterprise development. WorldVision’s intention to serve the poorest of the poor is a

higher priority than a desire to minimise the chal-lenges this objective poses. FFP PRODEM targets arange of incomes, with service delivery to wealthierclients supporting programming for more challeng-ing clientele (e.g. poorer, more remote, rural). BRACsimilarly uses BRAC Bank, which serves MFI gradu-ates, to finance services that are not sustainable.The range of partnership options poses variousdegrees of potential flexibility. Partnering with thepoor affords the most flexibility for a service delivererin that the poor themselves will select services ornot, more or less as given. Internal partnerships mayfacilitate flexibility as it is likely to be easier to adjustinternal processes from within organisations thanbetween them, as is required for inter-organisationalpartnership. The required flexibility will also dependon the degree of integration required to meet part-nership objectives, with information sharing requiringthe least and joint action the most. An additional recurrent, even universal, theme isthat of avoiding artificiality. All of the organisa-tions reviewed place a high premium on financialsustainability of MFIs, as well as the microenterpris-es they support. Because of this, Save the Children’smicrofinance program will not add new servicesunless they can be sustainable; and while it mayinternally partner, it discourages making comple-mentary services a requirement of their microenter-prise development programming. Similarly, WorldVision emphasises its four Ss.

I M P L I C A T I O N S A N D C O N C L U S I O N

Poverty traps suggest that multi-sectoral program-ming may be required for sustainable poverty reduc-tion. I outlined three scope options, with partner-ship offered as a distinct possibility. However, a closerexamination of selected experience in microenter-prise development reveals that the partnership con-cept may, in fact, encompass components of each ofthese options. Partnering with the poor enablesorganisations to remain specialised on microenter-prise development, trusting that the poor will capi-talise on multi-sectoral services available from otherproviders. Internal partnering enables multi-sectoralorganisations to provide services in coordinated,though perhaps not thoroughly integrated ways,securing at once the advantages of multi-sectoralapproaches and partnership efficiency and effective-ness. The third option, inter-organisational partner-ship remains an important one.By exploring environmental hostility, we can beginto identify those circumstances that call for differenttypes of partnerships. If the ultimate objective is sus-tainable poverty reduction, partnering with the poormay only be appropriate when other providers areeasily accessible to the poor. When this is not thecase, internal or inter-organisational partnershipsmay be required to ensure the availability of multi-sectoral services, whether by referral and information


sharing, addressing specifically identified obstacles toservice access, and/or coordinating among variousprogram units or organisations.These prescriptions only hold when actors strategi-cally prioritize poverty reduction, with attention topoverty traps and the services necessary to addressthese. Many organisations remain focused on nar-row perspectives of organisation identity and com-parative advantage. Such organisations can makeimportant contributions to poverty reductionefforts. However, ensuring sustainable povertyreduction with this approach is likely to remain ahappy accident for such organisations rather thana strategic effort. Explorations such as this article’scan encourage NGOs to think more strategicallyabout ultimate aims and the full range of optionsfor reaching them. ©

—————1 On September 8, 2000, the 189 member states of the UnitedNations adopted the UN Millennium Declaration, whichincludes eight Millennium Development Goals (MDGs) toaddress development and the eradication of poverty by 2015.See http://www.developmentgoals.org.

2 See Ouchi (1979, 1980). The reference to bureaucracyshould not be confused with structure; rather it refers to anapproach for influencing behavior through established rules andprocedures. These governance mechanisms have also been referredto as price, authority, and trust (Bradach and Eccles 1991).

3 Artificiality is the extent to which resources outside theimmediate environment are available; subsidies for inputs makepartnerships vulnerable to their removal.

4 This description draws from Hatch (2005).5 This overview draws from Conly (2005).6 This overview draws from Norell (2005).7 This overview draws from Hattel (2005).8 This overview draws from Ahmed (2005) and Hattel (2005).

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NORELL, DAN, Team Leader, Microenterprise Develop-ment World Vision. Presentation at “The Effective-ness of Multiplex vs. Specialized Approaches toMicroenterprise Development,” GE InternationalNGO Team Roundtable, George Washington Uni-versity, Washington, DC, April 8, 2005.

OUCHI, WILLIAM G., “A Conceptual Framework for theDesign of Organizational Control Mechanisms”, inManagement Science September (1979): 833-848.

——, “Markets, Bureaucracies and Clans”, in Adminis-trative Science Quarterly 25 (1980): 129-141.

PETERS, B. GUY, “Managing Horizontal Government:The Politics of Co-ordination”, in Public Adminis-tration 76 (1998): 295-311.

SMITH, STEPHEN C., Ending Global Poverty: A Guide toWhat Works, New York: Palgrave 2005.

a b


Dr. Jonathan H. Westover is anAssistant Professor of Business atUtah Valley University. He is alsoa human resource developmentand performance managementconsultant. His ongoing researchexamines issues of global develop-ment, social entreprenurship,work-quality characteristics, andthe determinants of job satisfac-tion cross-nationally.

I N T R O D U C T I O N

O V E R T Y H A S D I F F E R E N T

meanings to differentpeople and is thesource of much debate

in the public arena. This islargely due to the fact there aremany potential causes ofpoverty, ranging from thosethat could be categorised ascauses stemming from one’s personal choices andactions, causes stemming from structural con-straints and inequalities in society, and causes thatarise from government welfare entitlement pro-grams. As a result of such a wide and diverse arrayof potential poverty causes, there are an equallylarge number of proposed policy interventions andsolutions designed to eradicate the problem ofpoverty, some addressing each of the differentareas mentioned above. One potential solutionthat has been increasing in popularity, and contro-versy, in recent years is the area of microfinance.However, despite the increased popularity, what isthe record of such programs? Furthermore, what isthe effectiveness/ ineffectiveness of such programson reducing poverty? Finally, what are the pre-dominant methodological approaches in themicrofinance literature? As with any interventionstrategy, as the number of microfinance programsinstituted throughout the world continues toincrease, formal investigation into the effectivenessof such programs is important.

In this paper I will provide a brief overview of evi-dence from the existing literature on microfinanceto show the current performance record of suchprograms and the effectiveness/ineffectiveness ofsuch programs on reducing poverty. Furthermore,I will discuss some criticisms of the microfinance

approach to eradicating povertyand provide a critique of themethodological foundation ofmicrofinance as a whole, aswell as the increased number ofimpact studies that have beenconducted in recent years.Finally, I will draw several con-clusions on the appropriatenessand effectiveness of microfi-nance programs in addressingthe problem of world poverty,while providing several sugges-tions for future research direc-tions in this developing field.

B A C K G R O U N D T O

M I C R O F I N A N C E

Poverty is a world-wide pover-ty epidemic. Figure 1 belowillustrates that though extremepoverty rates have been declin-

ing across many regions of the world in recentdecades, high rates still persist. Furthermore, it isestimated that about one-sixth (500 million of anestimated 3 billion) of poor people throughout theworld have access to formal financial services(World Bank, 2005). This represents a large gap inaccess to such services.One approach to reducing this gap that hasincreased in popularity in recent years has been theformation of microfinance institutions (an estimated7,000 microfinance institutions serving approximately16 million poor individuals in developing countries)(World Bank, 2005). However, Figure 2 illustrates thelarge gap that still persists between need and theaccess of microfinance services available to theworld’s poorest families (see Daley-Harris, 2009). The idea of microfinance started in Bangladesharound 1976 with Muhammad Yunus andGrameen Bank (recently awarded the Nobel PeacePrize for his work). Microfinance refers to financialservices offered to low SES individuals that areexcluded from the traditional financial system


P

T H E I M PAC TO F M I C RO F I N A N C E

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(considered “unbankable” – lacking collateral,steady employment, and a verifiable credit history).Aspects of microfinance, such as microcredit, aredesigned to help lift individuals, families, and com-munities out of poverty by providing small amountsof start-up capital for entrepreneurial projects, whichwill then presumably help individuals to generateincome, build wealth, and exit poverty. One aspect of microfinance that distinguishes itfrom the traditional financial system is the “jointliability concept,” wheregroups of individuals,usually women, grouptogether to apply forloans, and hold jointaccountability for repay-ment of the loan. Thepremise is that provid-ing low SES individualsaccess to financial ser-vices will better enablepoor households tomove away from subsis-tence living, to a futureoriented outlook on lifeand an increased invest-ment in nutrition, edu-cation, and livingexpenses. Furthermore,microfinance is unique asa development toolbecause of its potential tobe self-sustaining (bothreducing poverty andmaintaining a profitablebusiness) (BusinessWeek, 2005).

R E P O R T E D

S T R E N G T H S / P O S I -

T I V E I M P A C T S O F


P R O G R A M S

A variety of studies havefound a few key strengthsand positive impactsproduced by the imple-mentation of microfi-nance programs in poorand impoverished areas of the world. First, micro-finance programs can be an effective way to providelow-cost financial services to poor individuals andfamilies (Miller and Martinez, 2006; Stephens andTazi 2006). Second, such programs have beenshown to help in the development and growth ofthe local economy as individuals and families areable to move past subsistence living and increasedisposable income levels (Khandker, 2005). In addition, many studies (primarily microfinanceinstitution impact studies and academic researcher

qualitative or case studies) have shown that micro-finance programs were able to reduce povertythrough increasing individual and householdincome levels, as well as improving healthcare,nutrition, education, and helping to empowerwomen. For example, standard of living increases,which help to eradicate extreme poverty andhunger, have occurred at both the individual andhousehold levels as a result of microfinance pro-grams (Khandker, 2005). Furthermore, it has been

demonstrated by someresearch that microfi-nance programs increaseaccess to healthcare, mak-ing preventative health-care measures moreaffordable to the poor. Inaddition, more childrenare being sent to schooland staying enrolledlonger (Morduch, 1998).Finally, it has been shownthat such programs canhelp borrowers to devel-op dignity and self-confi-dence in conjunctionwith loan repayment, andself-sufficiency as a meansfor sustainable incomebecomes available. Sincemicrofinance services areprimarily focused onwomen, it is argued thatthis leads to the empow-erment of women andthe breaking down ofgender inequalities,through providingopportunities for womento take on leadershiproles and responsibilities(Goetz and Gupta, 1995).

R E P O R T E D

P R O B L E M S / N E G A T I V E

I M P A C T S O F


P R O G R A M S

In contrast to the variouspositive impacts and

strengths of microfinance programs listed above,other studies (more quantitative, with appropriatetreatment/control frameworks and comparisonsmade across larger samples) have found several keyproblems and negative impacts produced by theimplementation of microfinance programs in poorand impoverished areas of the world. First, somestudies have shown that microfinance programsbenefit the moderately poor more than the desti-tute, and thus impact can vary by income group


FIGURE 1: EXTREME POVERTY RATES IN WORLD REGIONS.

FIGURE 2: ACCESS TO MICROFINANCE SERVICES.Source: State of the Microcredit Summit Campaign Report 2009.

(better-off benefit more from micro-credit) (Copes-take et al., 2001; Morduch, 1998; Dugger, 2004). Sec-ond, most microfinance programs target women(due to higher repayment rates), which may resultin men requiring wife to get loans for them (Goetzand Gupta, 1995). Third, examples exist of a viciouscycle of debt, microcredit dependency, increasedworkloads, and domestic violence associated withparticipation in microfinance programs (Copestakeet al., 2001; Morduch,1998). Fourth, studieshave shown that thereare low repayment ratesin comparison with tra-ditional financial institu-tions (Miller and Mar-tinez, 2006; Stephens andTazi, 2006), thus possiblycontradicting one of thekey strengths listed above,that such programs canlead to empowermentand increased self-confi-dence through responsi-ble loan repayment.Fifth, there have beenreports of the use ofharsh and coercive meth-ods to push for repay-ment and excessive inter-est rates (Business Week,2005; The FinancialExpress, 2005). Finally,concerns have beenraised that the relianceon microfinance pro-grams to aid the poormay result in a reduc-tion of government andcharitable assistance(“privatisation of publicsafety-net programs”)(Neff, 1996).

M I C R O F I N A N C E A S

A M E A N S

T O A L L E V I A T E

P O V E R T Y ?

Based on the findingsreported above, there are mixed conclusions as tothe overall impact of microfinance institutions. Thisleads us to the key question of this paper: What isthe effectiveness/ ineffectiveness of microfinanceprograms on reducing poverty? Some studies havefound marked decreases in overall poverty levels,including declining levels of extreme poverty(Khandker, 2005), while other studies do not findthe same direct effect (Morris and Barnes, 2005;Kan, Olds, and Kah, 2005; Goetz and Gupta, 1996).Still, other studies provide mixed results (Copestake,

Bhalotra, and Johnson, 2001; Morduch, 1998). Thus,the academic literature is mixed in regards to thespecific impact that microfinance has on alleviatingpoverty. Many impact studies and other similarassessments find great strengths and positiveimpacts of such programs on reducing poverty,while other studies report that such positive impactsmay be over-reported and even inaccurate, whilepointing out some fundamental flaws with such

study designs. The question is, whichgroup of studies is cor-rect, and to what extent?At this point in the liter-ature, there are few sta-tistically and method-ologically sounds strin-gent evaluations ofmicrocredit programsgenerally viewed as cred-ible by experts. Much ofthe academic literaturereporting positive resultsof the impact of microfi-nance programs inreducing poverty usequalitative methods,look at single cases orspecific areas or regions,use cross-sectional data,analyse self-reportedmeasures, and use non-random sampling proce-dures, resulting in find-ings that cannot be easilyreplicated nor gener-alised to all programs. Incontrast to the commonqualitative and case-study approaches in theless rigorous body ofresearch, only a handfulof studies use sizeablesamples and appropriatetreatment/control frame-works to answer thequestions of real impactand effectiveness. AsMorduch said in his cri-

tique of the existing literature methodology, “Whilestrong claims are made for the ability of microfi-nance to reduce poverty, only a handful of studiesuse sizable samples and appropriate treatment/con-trol frameworks to answer the question” (1998, p. 1).Until more such studies are conducted and findingsreported, we must take the findings of less rigorousimpact studies with a grain of salt and not be tooquick to generalise findings of the impact and effec-tiveness of a specific program, in specific location, ata specific time, to other cases.


F U T U R E D I R E C T I O N S

I am encouraged by the increasing popularity ofthe growing microfinance movement and recog-nise it as a pioneering approach to addressing theproblem of poverty. There are numerous studiesthat demonstrate the tremendous successes of suchprograms throughout much of the underdevelopedworld. However, despite the increase in the popu-larity of microfinance programs and the vastamount of research conducted to date, there aretwo key areas for future academic research into theeffectiveness of microfinance programs. First and foremost, more stringent evaluations ofmicrocredit programs are needed. Various feasibili-ty and impact studies have shown the financial via-bility of such programs in being self-sustainableinstitutions, but the question of the effectivenessand impact on the poor of such programs is stillhighly in question. Many studies use a case-studyapproach to looking at the effectiveness of a givenprogram in a given region at a given time, but feweffectively measure the impact of multiple pro-grams. To be able to say once and for all that theseprograms are or are not effective at reduce povertywill require a large sample of programs with datathat can be rigorously analysed, with replicablemethods and generalizable findings. Second, there are considerable practical debatessurrounding the implementation of microfinanceprograms that have yet to be answered. Thesedebates include a fundamental theoretical debatebetween large-scale, top-down funding of majordevelopment projects versus small-scale, bottom-upfunding to individuals and households as a meansof alleviating poverty. Additionally, there are ques-tions surrounding the potential of microfinanceprograms to cannibalise other programs, includinggovernment assistance and aid. Furthermore, thereare still questions as to the potential of microcredithurting the poor and creating a kind of microcreditdependency. Finally, as microfinance programs aregeared almost exclusively to woman, there is adebate about the appropriateness of such a policyand the possible exploitation of women. Thereforefurther research needs to be conducted to examinethese facets of microfinance programs.

C O N C L U S I O N

Despite the popularisation of microfinance in themass media and the many positive findings that arereported in some feasibility and impact studies, thereare also many studies that report some negativeimpacts of such programs and fail to find a direct linkbetween microfinance program involvement andpoverty reduction. Thus, at this point, NGO lead-ers and government policy makers must exercisecaution and restraint in applying the microfinanceapproach universally as a means of alleviatingpoverty and continue to conduct rigorous

research that will better answer the questionsaddressed in this paper. ©

—————* Author’s Note: This article is adapted from a previous ver-sion of this paper, entitled “Trickle-Up Economic Develop-ment: A Critical Examination of Microfinance Programs”,in The International Journal of Environmental, Cultural,Economic and Social Sustainability, 6(4), 2010: 1-10.

R E F E R E N C E S

COPESTAKE, JAMES ~ BHALOTRA, SONIA ~ JOHNSON,SUSAN, “Assessing the Impact of Microcredit: AZambian Case Study”, in The Journal of DevelopmentStudies, 37(4), 2001: 81-100.

DUGGER, CELIA W, “Debate Stirs over Tiny Loans forWorld’s Poorest”, in New York Times, 2004.

GOETZ, ANNE MARRIE ~ GUPTA, RINA SEN, “Who Takesthe Credit? Gender, Power and Control overLoanUse in Rural Credit Programmes in Bangladesh”, inWorld Development, 24 (1) 1996: 45-63.

KAH, JAINABA M.L. ˜~ OLDS, DANA L. ~ KAH, MUHAM-MADOU M. O, “Microcredit, Social Capital, andPol-itics”, in Journal of Microfinance, 7 (1) 2005: 121-151.

KHANDKER, SHAHIDUR R, “Microfinance and Poverty:Data from Bangladesh”, in The World Bank Econom-ic Review, 19 (2) 2005: 263-286.

“Large NGOs Becoming Rockefellers”, in The FinancialExpress, November 22, 2005.

“Micro Loans, Solid Returns: Microfinance Funds LiftPoor Entrepreneurs and Benefit Investors”, in Busi-ness Week, May 9, 2005.

MILLER, JARED, AND MARTINEZ, RENSO, “ChampionshipLeague: An Overview of 80 Leading Latin AmericanProviders of Microfinance”, in Microbanking Bul-letin, 2006.

MORDUCH, JONATHAN, “Does Microfinance ReallyHelp the Poor? New Evidence from Flagship Pro-grams in Bangladesh”, in MacArthur Network,Princeton University 1998.

MORRIS, GAYLE ~ BARNES, CAROLYN, “An Assessment ofthe Impact of Microfinance”, in Journal of Microfi-nance, 7 (1), 2005: 40-54.

NEFF, GINA, “Microcredit, Microresults”, in The LeftBusiness Observer 74, 1996.

DALEY-HARRIS, SAM, “State of the Microcredit SummitCampaign Report”, in Microcredit Summit Cam-paign, 2009.

STEPHENS, BLAINE ~ TAZI, HIND, “Performance andTransparency: A Survey of Microfinance in SouthAsia”, in Microbanking Bulletin, 2006.

a b


Simona Sapienza was educated atthe Sawyer Business School (Pitts-burgh, US), at the University of Rome«La Sapienza» where she received herMA in Law and PhD.Ms Sapienza has held various acade-mic positions in Italy and has beenlegal counsel for the Italian Instituteof Research for the international pro-tection of human and civil rights. Shehas been actively engaged in support-ing NGOs projects associated with theDepartment of Public Information ofthe UN and in inter-cultural projectspromoted by the EU Commission.Ms Sapienza is currently Senior Asso-ciate in the International CapitalMarkets department of Allen & Overy(Rome), which she joined in 2000.Ms Simona Sapienza is a Boardmember of the Spanda Foundation.

ICROFINANCE IS ANOTHER

term for microcredit, (1) which is definedas the lending of small amounts of moneyto low interest to new business in the devel-oping world,” this the official definition1.

Although clear, this definition may need somerevision in particular in the light of the socio-demographic changes which over the last decadeshave significantly altered the world economic sce-nario. Actually, for microfinance the new contexthas meant different potential beneficiaries withdifferent financial needs and a greater involvementof financial intermediaries. Traditionally microfinance has been associated withprogrammes that benefit people with serious subsis-tence problems in developing countries. This is whymicrofinance may overlap easily with microcredit:small loans, often without traditional guarantees,aimed at improving the lives of the beneficiaries andtheir families or at sustaining micro-economic activ-ities. The resources, coming mainly from fundsdonated by states and supranational organisationsor by individuals and foundations, are channelled to

their recipients usually through NGOs and localpartners. In this scenario NGOs and donor countrieshave been operating together with other locally-based organisations, such as municipalities or gov-ernments or other entities from the third sectorhelping to facilitate the screening and management

of credit positions. In order toreduce the often cultural gapbetween lenders providing cred-it and the beneficiaries of themicroloans many organisationshave relied to networks of localpartners visiting potential bene-ficiaries to gather informationduring the selection and moni-toring phase and later to collectthe different installments relat-ed to the micro-loans granted.The traditional beneficiaries oftraditional microfinance there-fore have been citizens of devel-oping countries sadly known asthe “poorest of the poor”. With-in this category, women havebeen of particular importanceas the group most affected byfinancial exclusion and, at thesame time, more capable thanmen to repay and manage thefunding received in smallincome initiatives [SEE GRAPH 1].

In the last few years microfinance has served a groupof beneficiaries largely distinct from the one tradi-tionally associated with microcredit. More recentlymicrofinance has open up to self employed workersand individuals in charge of small, often familyowned business, which are simply not able to accesscredit from banks. For micro-entrepreneurs, microfi-nance has become an alternative to credit given byinformal lenders and a way out of the money lend-ing system. Furthermore, actual potential microfi-nance beneficiaries include individuals who,although not living in poverty, may have general dif-ficulty in gaining access to the financial system.As a matter of fact today exclusion from the tradi-tional credit system includes millions of people andit can be the consequence of other forms of exclu-sion, primarily from the socio-political system.Immigrants or ex-convicts may be, for instance, thevictims of such social and political exclusion and beamong the unbankable ones. Furthermore, a form offinancial exclusion can be the one affecting cus-tomers, mainly small-scale entrepreneurs, considered


M I C R O F I N A N C EY E S T E R D A Y , T O D A Y A N D T O M O R R O W

S I M O N A S A P I E N Z A

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marginal by credit institutions as they represent alow-value target compared with the traditional cus-tomer evaluation models. Although it may wellsound a paradox, it is this very group of unbankablepeople that, despite their common distance from thecredit system, are usually characterised by increasinglevels of professional and managerial ability, and increas-ing levels of cred-itworthiness.Up to yesterdaythe financialsystem regardedmicrof inancewith suspicion.Tr a d i t i o n a lfinance consid-ered offering credit to individ-uals seen as un-bankable when not backed up byguarantees, as a too risky business. Moreover, theprocess of supplying small loans incurs excessivecosts owing to the significant operating cost need-ed to deal with each loan in relation to the amountof credit supplied.In recent microfinance experience, however, we arewitnessing a cross-over movement, which is seeinga greater involvement of banks and microfinancefinancial intermediaries in programmes destinedfor the poorest of the poor, the poor and theunbankables, and a parallel involvement of NGOsand microfinance financial intermediaries in pro-grammes aimed towards marginalized beneficiaries. The continuous increase of un-bankable and mar-ginalized people in the world is determining agreater complexity of the financial structures inmicrofinance programmes and, therefore, a moresignificant move away from the traditional pat-terns of microcredit.Microfinance is no longer just a financial techniquemainly offered by the non-profit sector as part ofdevelopment programmes to sustain the poor indeveloping countries. It has become something dif-ferent. Despite the challenges which remain inattracting private capital, lowering costs and interestrates and developing regulation, it has slowly becomean established part of the global capital structure.The modern microfinance market is characterised by acomplex demand for financial and technical servicesand a complex supply, owing to a growing interactionand interest on the part of institutional donors, thenon-profit sector and the financial markets.The increasing participation in microfinance pro-grammes of regulated financial intermediaries bringsmicrofinance closer and closer to traditional finance.The presence of intermediaries oriented towards profit,and the use of private funds, can represent a risk ofdeparture from the ethical nature of the social andhumanitarian objectives behind traditional micro-finance and of the channelling of funds throughnon-profit organisations lines. To prevent this and

to facilitate the development of a microfinance oftomorrow linked to the values of ethical finance, thenon-profit sector will still play a crucial role. NGOsespecially will have the important task of safeguard-ing the original features of microfinance, in particu-lar the ethicality of the business, the flexibility of theprocess and the proximity to the beneficiaries. They

will still be thebest organisa-tions to interactwith microfi-nance financialinstitutions andlocal govern-ments to pro-

pose projects linked to nationaland local development policies.

To lower intermediation costs to manage the risksassociated with microfinance project effectively, theentry in the microfinance market of non-bankfinancial intermediaries such as Ethical InvestmentFunds and Ethical Pension Funds will also be crucial.They may be an important source of low costfunding for microfinance, still much unexploited.Actually, savings collected from ethical investorscould find market investment alternatives in micro-finance that meet the ethical feature required. Inaddition, ethical savings do not incorporate a risk-return relation similar to traditional savings and,therefore, can be dedicated to investments thatensure rate of returns lower than market ones’.NGOs are in the position to select the most appro-priate beneficiaries for each project. They can offerthe human resources necessary to provide technicalassistance and training from the starting up of theproject until the exit strategy. They will have tocooperate with financial intermediaries to imple-ment an efficient credit process that reduces to theminimum the different costs that may arise fromasymmetric information and risk managementmodels. NGOs are already on the path and madeimportant contributions to poverty alleviation byaddressing quality of life issues such as health, edu-cation, environment and shelter, and by providingnew opportunities to beneficiaries.For the future, it is possible to foresee that microfi-nance programmes will be increasingly characterisedby stronger cooperation among stakeholders –international donors, governmental bodies, finan-cial intermediaries, NGOs, technology companies –using respective skills and institutional objectives tofoster the effectiveness of microfinance programmesand support ethical sustainability [SEE GRAPH 2]. The next decades of microfinance will bring newplayers to the field and will create alliances amongentities that would have been difficult to considerpartners a decade ago and who together will con-tinue to reinvent microfinance.


GRAPH 1 ~ Standard microfinance structure.

DONORS

LOCAL PERTNERS

NGOS

CREDIT OFFICERS BENEFICIARIES

NGOs that gave birth to this sector, have alreadystarted to reinvent themselves, some have trans-formed themselves into regulated financial entitieswhich operate principally by offering microcreditas part of development projects, often combined

with the offer of technical assistance and socialintervention for beneficiaries.Microfinance fits well in the context of the Millen-nium Development Goals (MDGs). Among themany important tasks that constitute the agendafor poverty eradication the UN Millennium Decla-ration calls for “microfinance projects which meetthe local community priorities”. From this pointof view, the new microfinance model becomes animportant component to meeting the MDGs of2015. This places greater pressure on the new actorsof microfinance to address the challenges and toseize the opportunities of the next years so that in2016 microfinance will have realised the vision,

assuring access to financial services to the world’smajority ©

—————1 Oxford English Dictionary, 2009.


GRAPH 2

INSTITUTIONS SERVICES BENEFICIARIES

POOREST AND POOR UNBANKABLES-MARGINALIZED

GOVERNMENTS GRANTS X

DONORS GIFTS X

NON-PROFIT NGOS DONATIONS X

FINANCIAL NGOS LOANS X

BANKS CREDIT/TECHNICAL SERVICES X

MICROFINANCE INVESTORS CREDIT/TECHNICAL SERVICES X

FINANCIAL INTERMEDIARIES CREDIT/TECHNICAL SERVICES X

Anant Jayant Natu is an Electronicsand Telecommunications Engineerwith a Post Graduate Diploma inRural Management from the Insti-tute of Rural Management (IRMA).Throughout his career, he has playeda crucial role in the incorporation ofGrameen Capital India Ltd. (GCIL),IFMR Trust and IFMR Foundation,whilst working as a Manager atICICI Bank’s Social Initiatives Group(SIG). With SIG, he was responsiblefor monitoring the projects mandat-ed to provide support to research andacademic institutions, technical ser-vice providers and other entities in themicrofinance sector. Amongst otherachievements, he has co-authored apaper on NREGP and financialinclusion.He has expertise in drawing businessplans and projections, deliveringtraining and conducting institution-al assessments. Since he joinedMicroSave, he has worked with over30 MFIs and other types of financial institutions across India,the Philippines, Sri Lanka and South Africa. Recently,Anant has been spearheading critical work on marketresearch, product development, pilot-testing and productrollout for an MFI in India. His areas of interest includerapid institutional assessment, process mapping, strategicbusiness planning, capital structuring and equity valuation,internal audit and controls, and training for bankers.

I N T R O D U C T I O N

ICROFINANCE IN INDIA HAS EVOLVED OVER THE

past two decades since its inception inthe early 1990s. The SHG-bank linkagemodel, its first prototype, was the off-spring from an unlikely marriage

between the social intermediation role of the civilsociety and the financial intermediation of banks,with RBI and NABARD acting as more than willingmidwives. As the business potential of microfinance dawnedon many, microfinance institutions (MFIs) took on

the task of both the social and financial intermedi-ation. Thus an alternate channel for microfinancearrived (somewhat belatedly by comparison toelsewhere in the world). This was second-genera-tion microfinance for India. Most of the MFIsadopted the Joint Liability Groups (JLGs) methodol-

ogy and standardisation becamethe new mantra for achievingrapid growth. Over the past 2-3years, NBFC-MFIs operatingunder predominantly JLG-basedmethodology have emerged asa significant and rapidly grow-ing force. Nonetheless, SHG-based systemsstill serve three quarters of theoverall microfinance clients inIndia and have two-thirds of thetotal loan outstanding1. Somewould argue that SHG-basedmodels are still the most relevantmodel for certain segments ofIndia’s poor. Nonetheless, thereis growing evidence of signifi-cant problems with SHG-basedmodels’ portfolios2, and someissues within those of JLG-basedMFIs, particularly in competitiveareas of the country. With com-petition comes change.

T H E C H A N G I N G E N V I R O N M E N T :

A T E C T O N I C S H I F T ?

Interestingly, the formal, public sector financialinstitutions (Regional Rural Banks, CooperativeBanks etc.) are still not competing in the microfi-nance market. However, the burgeoning numberof MFIs, and the relatively narrow focus of theirproducts, has meant that intense competition hasemerged, particularly in the southern states and insome limited areas of the east. This has providedmicrofinance borrowers with unprecedented accessto credit and has been a boon for them, but notwithout the concomitant vices of competition.Many of the larger MFIs are now responding to thedemands of their commercial equity investors forvery rapid expansion by adopting a ‘sales’ drivenapproach for increasing outreach. The dash forgrowth has also seen several MFIs overstretch theirmanagement capabilities and systems, resulting insignificant portfolio problems.


M A R K E T S T R A T E G Y D E V E L O P M E N TAND 3RD GENERATION MICROFINANCE IN INDIA

A N A N T J A Y A N T N A T U

M

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original

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g | N E W D I R E C T I O N S

In addition, there is growing evidence of clients‘patching’ loans together from several MFIs in orderto meet their needs for finance. For example, a highyield heifer costs around Rs. 30,000 (USD $600) – morethan any one Indian MFI will lend under a traditionalgroup-based system. The proliferation and massivegrowth of MFIs has meant that (so long as they arewilling to sit in the groups each week) clients canaccess three (or more) loans from different MFIs.Unsurprisingly, while many clients successfully takemultiple loans to finance larger projects, othersbecome over indebted – this has led to growing signs

of stress in MFIs’ portfolios, most dramatically evi-denced in the Kolar district in Karnataka3. To respond to the cutthroat competition, MFIs aretrying out different approaches that range from thedesperate to the deliberate. The desperate measureshave bordered on the unethical ‘poaching’ of bothcredit officers and even groups from rival MFIs.Other more deliberate attempts have included offer-ing individual lending (IL) product to their oldclients4. Nevertheless, the design of many MFIs’ ILproduct is hardly different from their group loans –except that group guarantee is replaced by a singleguarantor. Basic evaluation of the enterprise is usual-ly performed, but the product is rarely customised torespond to cash flows, or even the financing needs,but rather reflects a pre-defined stepped loan sched-ule. In addition, few MFIs invest in the skill setsrequired for a successful IL programme5.In being ‘reactive’ to the competition (and in somecases their private equity investors), many MFIs arelosing sight of the raison d’être of their existence -their clients. It is increasingly clear that the chal-lenges of competition must be countered by bring-ing clients back as the ‘focus’ of their business. Thisshift in focus will bring a ‘tectonic’ change in theway MFIs do microfinance and see the emergence of3rd Generation microfinance institutions (3G-MFIs).

3 G M I C R O F I N A N C E I N S T I T U T I O N S :

‘ E X P A N S I O N ’ T O ‘ E N G A G E M E N T ’

A 3G-MFI is continually asking itself one basic ques-tion: “What share of my client’s financial needs is being

met by us?” It will seek to be a “one-stop-shop” for allher financial needs in a manner that “delights” her.The very mission of the 3G-MFI sets it apart from itscompetitors, as it no longer treats its client as a head-count, but as an individual with dynamic needs. One distinct feature of any 3G-MFI is their long-termmarket strategy. They consciously choose to pursuethe strategy of product modification and new prod-uct development over market penetration and geo-graphic expansion. This shift of strategy from ‘expan-sion’ to ‘engagement’ is shown in the figure below 6.

3G-MFIs will see growth in terms of improvements intheir clients’ financial well-being, and the MFIs’ abilityto serve them over a long period of time. Some MFIsare even looking at using full lifetime value of cus-tomer analysis as a basis of their planning. 3G-MFIswill also grow horizontally, but this will not be theirdominant strategy; and they will grow horizontallyonly to an extent that does not compromise theirengagement with existing client segments.

3 G M F I : H O W W I L L T H E Y D O I T ?

A 3G-MFI will operationalise the strategy of deepen-ing engagement by:1 ~ Offering clients a suite of financial services inresponse to their full spectrum of financial needs,including; credit, savings, remittances, insurance etc.2 ~ Focusing on convenience for all clients, so thatproducts respond to the needs of the client, andnot just those of the institution.3 ~ Leverage technology, particularly e-/m-bankingto increase transaction efficiency and reduce costs.~ Add supplementary services, such as ‘liveli-

hood’ services or education/food security services 7

or possibly even health services.One of the pioneers of 3rd generation microfinancehas been the IFMR Trust Holdings, which provides‘wealth management’ support to its clients. Wealthmanagement is a notion that transcends product-centric thinking and the traditional focus on out-reach alone. The wealth management perspectivecalls for institutions that are embedded within the


P R O D U C T

EXISTING MODIFIED NEW

EXISTING

MODIFIED

NEW

Sell more of our existingproducts to our existingcustomers.(Market penetration).

Enter and sell our productsin other geographic areas.(Geographic expansion).

Sell our existing productsto new types of customers.(Segment invasion).

Modify our current prod-ucts and sell more of themto our existing customers.(Product modification).

Offer and sell modifiedproducts to new geographi-cal markets.

Offer and sell modifiedproducts to new types ofcustomers.

Design new products thatwill appeal to our existingcustomers.(New Product modification).

Design new products forprospects in new geographicareas.

Design new products to sellto new customers.(Diversification).

MA

RK

ET

community and growing vertically, rather than hor-izontally. It means they will serve a limited set ofclients in a more comprehensive manner, ratherthan be spread across a large number of clientsacross geographies. It also entails that the institu-tion offers its services to all people in the commu-nities it serves8.

C H A L L E N G E S F O R 3 G - M F I

Since 3G-MFIs look at microfinance from a differ-ent perspective, they need do things differentlyfrom other 3G-MFIs,specifically: 1 ~ Train the front-line

staff intensively forthem to be able toprovide ‘wealth man-agement’ advice.

2 ~ Offer savings servicesthrough Money Mar-ket Mutual Funds orother collaborations.

3 ~ Tie-up with otherinstitutions to pro-vide tailored remit-tances, insurance,pensions and other prod-ucts and services.

4 ~ Optimise the use of technologyto allow tie-ups and reduce time spenton processing and back-end operations.

C O N C L U S I O N

Given the saturation in a growing number of geo-graphic markets, it is imperative for the MFIs toshift from a ‘product-centric’ to a ‘client-centric’approach. The product-centric approach workedin uncompetitive markets with a huge demand-supply gap, and where the imperative was for rapidexpansion. But as the number and outreach ofMFIs has grown, supply is no longer a constraint inmany regions.Clients are in a position to pick-and-choose theMFI that offers them the most value. The 3G-MFIswill be quick to sense this ‘tectonic shift’ in thedynamics of the highly competitive markets, anddo everything they can to put the client back atthe centre of their business. This focus will trans-late into a respect for client’s time and dignity, andinto making the entire spectrum of financial ser-vices for the client’s livelihood available to them –a welcome prospect for both clients and those whobelieve in microfinance as a service for develop-ment and poverty eradication. ©

—————1 ‘Bharat Microfinance Report: Quick Data-2009’, Sa-Dhan.

2 See MicroSave, India Focus Note # 15, ‘Delinquency inSelf Help Groups’.

3 See MicroSave, India Focus Note # 25, ‘Dinosaurs andRabbits’.

4 Six of the top 50 MFIs in India are offering IL product.Refer “India Top 50 Microfinance Institutions; October 2009;CRISIL ratings.

5 See MicroSave, India Focus Note 14, ‘Challenges ofIntroducing Individual Lending in India’ and MicroSave, IndiaFocus Note 34, ‘Risks and Challenges in Individual Lending’.

6 Based on the ‘Kotler on Marketing: How to Create Winand Dominate Markets’.

7 Equitas is building insuch services.8 IFMR Trust Synthesis

N e w s l e t t e rAugust 2009.


Alberto G. Brugnoni, a former pri-vate banker with Merrill Lynch, is anindependent adviser of internationalfinance. He has conceived, structuredand implemented projects for Institu-tions of the European Union, Inter-national Organisations, Public Agen-cies, Companies, International LegalPractices, Banks, Management Com-panies, Universities, Associations, Pri-vate Clients, Stakeholders’ Lobbies.His practice focuses on the creation ofwealth through the full implementa-tion of the ‘social capital’ and ‘territori-al added value’ concepts. An innovativeuse of the financial mechanisms andstructures applied to ethical moniesallows the emergence of new forms ofgovernance that take on account thesocial, cultural and economic inclusionof all parts of society. His unique work-ing experience combines the traditionalfinance, the ethical finance and theislamic finance sectors.Alberto runs ASSAIF, an Islamic finance-tailoring consultancyout of Italy and regularly contributes to the major Social,Ethical and Islamic Investment Forums worldwide.

Poverty can bring someone to a state of disbelief.Hadith of the Prophet (PBUH).

B A C K G R O U N D I S S U E S

S L A M I C F I N A N C E I S C U R R E N T L Y E X P E R I E N C I N G A

critical developmental issue with the growingdivergence between the aspirations of Islamiceconomics and the realities of the industry.

Rather than being part of the Islamic political eco-nomic thought, Islamic finance has been pursuingpolicies away from the theoretical underpinnings ofIslamic economics and has located a surrogate finan-cial framework in neo-classical economics. Islamicfinance institutions aiming at efficiency have ignoredand relegated the importance of social dimensionand failed to internalise social justice into their ownoperational function. In that predicament, Islamicfinance is perhaps best described as heterogeneous

financial products deprived of their value systemsand is nowadays suffering from the perception thatit is simply a rebranding of conventional finance andnot truly reflective of Islamic principles.On the one hand, Islamic economics provides

axioms and values that proposean ethical system of economicsand finance based on the onto-logical and epistemologicalsources of Islam: the Qur’an andthe hadiths. Its foundationalclaims are social justice, povertyalleviation and prevention ofexploitation while at the sametime emphasising social justice,needs’ fulfilment, wealth redis-tribution and postulating socio-tropic individuals. On the otherhand, a critical analysis oftoday’s IF institutions indicatesthat the pragmatic approachadopted by the industry haslead to the non-implementationof these values. The emergingwealth in the Muslim world andthe staggering rate of growth ofthe Islamic finance institutionsassets-base coupled with theweak development of the con-temporary discourse of Islamic

economics has forced Islamic finance to blindlyadhere to the well-known precepts of a neo-classicalparadigm of managing wealth. By doing so, it hasweakened the entire social justice discourse ofIslamic economics and has not made any significantcontribution to the betterment of the lives of com-mon Muslim individuals.Nowhere this issue has become apparent as in themicrofinance sector with the notable absence ofShariah-compliant products aiming at poverty alle-viation and the empowerment of micro-entrepre-neurs. Microfinance products have indeed beenquite successful in Muslim majority countries withlarge microfinance banks operating in Indonesia,Bangladesh, Pakistan, Morocco, Egypt and Indiabut few of them are Shariah-compliant. Though44% of conventional microfinance clients worldwidereside in Muslim countries, the overall penetrationof microfinance in these countries is indeed irrele-vant. Conventional products do not fulfil the needsof many Muslim clients as Shariah compliance insome societies may be less a religious principle than


A SHARIAH-COMPLIANT MICROFINANCE FUND:A M U C H N E E D E D T O O L F O R T H E A C C O M P L I S H M E N T O F I S L A M I C E C O N O M I C ’ S G O A L S

A L B E R T O G . B R U G N O N I

I

“ Money is none

of the wheels

of trade: it is the

oil which renders

the motions of the

wheels more

smooth and easy. ”DD AA VV II DD HH UU MM EE

g | F U T U R E S

a cultural one with even the less religiously obser-vant preferring Shariah-compliant products. Allavailable evidence hints indeed at the existence of amarket of poor clients who strictly engage in Islamictransactions but also at a category of Muslim clientswho reluctantly use conventional products but pre-fer Islamic ones and would switch over once theybecome available. Unlocking this potential could bethe key to providing financial access to millions ofMuslim poor who currently reject microfinanceproducts that do not comply with the Shariah.From the Islamic perspective the concern aboutconventional microfinance rests upon the fact thatall the conventional models are interest-based which

makes their application unacceptable. Interest rates,high or low, are rejected by Muslims as tantamountto ribà, something that is prohibited in no uncer-tain terms by the Shariah. Indeed, one can say thatfinancial exclusion is exacerbated in Muslim soci-eties by the abhorrence to interest-based microfi-nance that prevents the access to banking or finan-cial services. Amongst other lacunas caused by theinterest rate system there are problems of adverseselection and moral hazards.According to the 2007 CGAP’s report, Islamic Microfi-nance: An Emerging Market Niche, Islamic microfi-nance has a total estimated global outreach of 380,000customers accounting for a meagre 0.5% of the totalestimated microfinance outreach of 77 million.Islamic microfinance institutions reach roughly300.000 clients through 126 institutions operating in14 countries plus an estimated 80,000 clients througha network of Indonesian cooperatives. In all Muslimcountries, Islamic microfinance is still in its infancyand accounts for a very small portion of the coun-try’s total microfinance outreach never exceeding 3%of outstanding microfinance loans. With 80% of itssupply concentrated in Indonesia, Bangladesh andAfghanistan, in other countries Islamic microfinancehas no scalable institutions reaching clients on aregional and national level. The average outreach of

the 126 institutions is only 2,400 clients with nonewith more than 50,000 clients.

T H E C A S E F O R A F O R - P R O F I T

A P P R O A C H I N I S L A M I C M I C R O F I N A N C E

Challenges in reaching a sustainable scale are main-ly due to the ‘not-for-profit culture’ nature of theIslamic microfinance institutions that are featuringan over-dependence on grants coupled with a lackof operational efficiency and proper risk manage-ment. This, and a want of product diversification,has resulted in an industry that is overall struggling,with most institutions not economically viable and

largely dependent on the availability of externalfunds. In this respect it should be noted that NGOsare the dominant players with 14 institutions reach-ing 42% and just two commercial banks reaching29% of the market. Other players are rural, villageand cooperatives banks.The overdependence on grants obliges Islamicmicrofinance institutions to constantly look forinjection of funds to keep running less their capitalis used to cover the operating costs. In addition,they have to ration their funds and thereby limitthe access of financial services to some people andgeographical areas. Furthermore, as a result of thisgrants’ addiction, Islamic microfinance institutionsdo not strive to collect extra saving which in turn isanother reason that prevents them from attainingself reliance and growth. Microfinance shouldindeed aims at building permanent local financialinstitutions that can attract domestic deposits, recy-cle them into loans, and provide other financial ser-vices. The UN Capital Development Fund estimat-ed in a recent study that there is potential for 7 mil-lion borrowers and 19 million savers, so it appearsthat the availability of microsavings products maybe more important than microfinancing, a factrecognised only recently.


Grants should be temporary start-up support, designedto get an institution to the point where it can tapprivate funding sources (investor with equity/loansand deposits). External funds are needed particu-larly during the initial stages of operation, whenthe savings of members are small but with the pas-sage of time as savings of beneficiaries accumulateand get recycled, the dependence on external fundsshould reduce. Though voluntary contributions tothe greater public welfare are a long standing andimportant aspect of the Muslim culture, currentMuslim philanthropy needs to become morefocused and utilise the available resources to tacklethe underlying causes of important social problemswithout confining itself to assuage the effects ofsocial issues. Unprece-dented wealth creationand gentrificationshould drive a new gen-eration of actors tochannel their privategiving into new institu-tional forms such ascapacity building inmicrofinance at themacro, micro and insti-tutional level with thekey bottleneck remain-ing the shortage ofmanagers. In thisrespect, an innovativeapproach should per-haps be considered withparticular reference ofthe obligatory zakat.To be sustainable the industry must shift from acharity-based donor-dependent approach to a mar-ket-based for-profits approach and clearly separatethe role of donors’ funds from that of private capi-tal. Traditionally, the private sector was viewed as apotential source of funds that would contribute todevelopment efforts from a desire to meet corpo-rate social responsibility objectives. More recently,it is recognised that the private sector can make asignificant contribution to achieving the Islamicmicrofinance institutions goals when its core busi-ness focuses on profitably (=sustainably) providingquality services at reasonable price.This for-profit approach will help addressing theissues of operational efficiency, risk management,transparency, product diversification and authenticity.It will also help establishing much needed perfor-mance benchmarks. Islamic microfinance must payfor itself if it is to reach a large numbers of people andunless microfinance providers cover their costs, theywill always be limited by the scarce and uncertain sup-ply of subsidies from governments and donors.

C O N V E N T I O N A L M I C R O F I N A N C E

A N D I S L A M I C F I N A N C E

Available evidence shows that the conventionalmicrofinance recipients better the quality of their

lives, generate more income for their households,create job opportunities within their own commu-nities and improve general living standards includ-ing nutrition, health, housing and education.In spite of the current divide, conventional microfi-nance institutions can find Islamic finance a naturalfit in their programmes, debt and equity-based alike.Microfinance the Islamic way has indeed the potentialnot only to respond to unmet demand but also tocombine the Islamic social principle of caring for theless fortunate with microfinance’s power to providefinancial access to the poor. Microfinance and Islamicfinance have much in common. Both emphasise thegood of society as a whole. Both advocate entrepre-neurship and risk sharing and believe that the poor

should take part in suchactivities. Both focus ondevelopmental andsocial goals and advo-cate financial inclusion.Both involve participa-tion by the poor.In the light of the abovearguments, the need ofa Shariah-compliantmicrofinance fund – ormicrofinance investmentvehicle (MIV) – struc-tured along the lines ofthe existent 103 fundswith total assets of USD6.6 billion, becomesapparent by the day.This vehicle should tar-get funds looking ini-

tially at Islamic microfinance as an alternative invest-ment, in which participants might like to engage,and subsequently as an asset class on its own, inwhich participants might like to invest. In thisregard, the fund should appeal to Islamic investorsbecause it will provide a convenient method ofacquiring a position in a new class of assets that com-bine the objective of having a social impact and pro-viding a return to the investors.The final outcome will contribute towards the inclu-siveness and integration of Islamic microfinance intothe Islamic finance and conventional microfinancesystems and it will initiate the journey towards thepooling of the USD21 billion needed to providemicro finance facilities to the world’s poorest 100million families.

a b


Manoj K. Sharma is a developmentfinance and SME specialist and coordi-nates the MicroSave India operations. As part of his responsibilities atMicroSave, he is involved in projectsfor downscaling commercial banks todevelop sustainable savings productsfor the low-end market and buildingthe institutional capacity of MFIs. Hehas been instrumental in enhancingthe acceptance of loan portfolio auditof MFIs as a tool for banks to basetheir lending/investment decisions, aswell as the individual lending toolkit.Manoj has conducted extensive workon strategic business planning forMFIs in India and the Philippines,and process mapping/analysis. Hisareas of interest include assistingmicrofinance institutions to start-up,product development, marketresearch and urban microfinance.

Graham A.N. Wright helped designand establish the MicroSave programme and pioneered muchof the core of the market-led approach used by MicroSave –in particular the Market Research for MicroFinance andmany related tools. Graham has provided training and technical assistance to avariety of microfinance institutions in Bangladesh, India, thePhilippines and throughout Africa.Graham has authored over 14 training toolkits and twenty-five papers, including the book Micro-finance Systems:Designing Quality Financial Services for the Poor (Universi-ty Press Ltd, Dhaka and Zed Books, London and New York,2000). He was chair of the CGAP Savings Mobilisation Work-ing and a member of the Product Development Groups, andis a Research Associate at the Institute of Development Policyand Management at the University of Manchester, UK.

H E R A P I D G R O W T H O F T H E M I C R O F I N A N C E

sector in the last few years has completelychanged its complexion and nature. Thegrowth has transformed microfinance:

from being a sub-set of the development sector ithas become a sub-set of the financial servicesindustry. Microfinance is already pushing towards

recognition as an ‘industry’ with a separate Act forregulation of microfinance institutions in the off-ing. This growth has put many issues and chal-lenges before the sector and one of the major con-cerns voiced about the sector has been that of ‘mis-sion drift’. Detractors of typical ‘Grameen’ replica-

tors have been saying for awhile that high rates of growthhave led to mono-products andmultiple lending to a vulnera-ble section of the population.Similar sentiments have beenvoiced by other stakeholders,and also the media. Variousissues have been brought out tohighlight the problems in themicrofinance sector and themain concerns are as follows:“In Karnataka or AP, it appearsthere is aggressive pushing ofloans without ascertainingrepayment capacity. In theevent of distress, there could bedefaults and the MFIs will take ahit. If the defaults are wide-spread, MFIs may find it diffi-cult to repay their bank loans.But, this is not a systemic prob-lem. The MFIs are too small forthat. The real concern is rural

women. Irresponsible lending can push them intodistress and impoverishment. And make banks waryof microfinance itself.” The Economic Times, March8, 2010 quoting the Deputy Governor of the ReserveBank of India, Mrs. Usha Thorat.

L A C K O F T R A N S P A R E N C Y

The microfinance industry has evolved from NGO1

roots. The push towards a ‘for-profit’ status to theindustry was primarily at the behest of banks. Thethinking in the early part of the decade of 2000 wasthat a Non-Banking Finance Company2 formatwould usher in transparency and bring the institu-tions under the ambit of the Reserve Bank of Indiamaking them ‘supervised’ entities and in theprocess, giving them some regulatory legitimacy.However, NBFCs needed to fulfil capital adequacynorms and most promoters from humble NGOroots did not have the wherewithal to bring inequity capital. (In those days, a CRAR of 10% hadbeen stipulated by RBI for NBFCs).


“ We may

become the

makers of our

fate when we

have ceased to

pose as its

prophets. ”KK AA RR LL PP OO PP PP EE RR

g | O U T L O O K

T I M E T O G E T B A C K T O B A S I C S ?M A N O J K . S H A R M A ~ G R A H A M A . N . W R I G H T

T

Working with a leading accounting firm, MFIs cameup with an innovative idea and for-profit trusts wereconstituted which took in money as ‘contributions’from a large base of ‘clients’ or ‘members’. The cor-pus thus created with the trusts was invested as cap-ital in the NBFCs. It was widely believed at that timethat the clients putting money in the trusts wereunaware that this was actually an equity investment.Over a period of time these trusts disappeared orreduced in size with the promoters or investors buy-ing out the community without, and at least insome cases, sharing with them the growth andreturns. Hence, while the route of forming trustswas not illegal, and was perhaps dictated by theneed to bringin the much-needed equity,the sectoralgrapevine wasabused withtales of unethi-cal, and insome cases ille-gal behaviourfrom MFI pro-moters. Theway the issueswere handledby the con-cerned MFIsand by othersectoral stake-holders, interms of trans-parency andethica l / lega lissues, left a lot to be desired.While the merits of the move to a for-profit statuscan be debated, it is apparent that the manner inwhich this occurred was not always above board.“Thus the privatisation of the community ownedentity was thus well on its way. The transforma-tion of microfinance as a vehicle for personalenrichment clearly was visible” 3.

P R I V A T E E Q U I T Y P U S H

The transformation of microfinance institutions toan NBFC format, largely pushed forward by banksand supported by the Small Industries Develop-ment Bank of India through its ‘TransformationLoan’, helped a for-profit orientation to emerge.Large institutions were able to bring down operat-ing costs, and the operating cost ratio4 reduced to8.5% in 2008 from 15.4% in 2006. Total cost ratio5 alsocame down drastically to 17.6% from 23.4% in thesame period. As against this, interest rates for ulti-mate clients continued to hover at around 30%, andthe industry margins were quite attractive. The highmargins and the seemingly limitless market, consid-ering the poverty levels in India brought private

equity (PE) players to the sector. The industry stake-holders and banks welcomed this move as it wasseen as a coming of age of the sector. A few voicesexpressed their concern that the entry of PE playerswould lead to rapid growth and commercialisationat a scale not seen before, but these were quicklybrushed aside in the initial euphoria.“We also find that by 2006, the individuals weregradually replaced by a substantial holding bymutual benefit trusts [MBTs] – a new special pur-pose vehicle discovered by the microfinance sector.These for-profit MBTs – the creation of an intelli-gent legal brain – were actually special purpose vehi-cles that would aggregate the borrower-members of

the microfi-nance organi-sations asmembers. Thegrant money inthe not-for-profit societywould findplace in theMBT and thisMBT in turnwould con-tribute to theshare capital inthe NBFC. Thishad two advan-tages – thecompanies didnot have todeal with alarge numberof retail share

holders on their books – but would be dealing withblocks of shareholders in the form of MBTs. Two,the trust deed would be drawn in a way that anemployee of the for-profit entity would act as a rep-resentative of these trusts in participating in thegeneral bodies of the companies – thereby retainingcomplete control over the so called ‘communityinvestment’ in the NBFC. Thus, by the time wecome to the middle of the decade, the charade ofthe community participation in the capital struc-ture of the company is also shed”6.The entry of PE players changed the game quitecomprehensively. The money brought in was short-term and needed high returns of the order of 24-30%7. The only way such returns could be realisedwas through rapid growth. The more money thatwas leveraged on account of equity, and the fasterit was turned around, the more profit would begained. Growth, which till then was being sup-ported by all stakeholders, became an end in itselfand was driven by profit – the client and her needsscarcely factored. The hard capitalists and stake-holders from other industries might feel that thereis nothing wrong with this, as profits are the dri-vers of growth. In addition, especially in a sector


where clients are not getting enough services,growth is inextricably linked to clients’ needs, andhence to client satisfaction.However, this may not be the complete picture inthe case of the microfinance industry as it continuesto be a ‘sellers-market’. As one expert repeatedlypoints out, “Microfinance is one of the last remain-ing supply led industries in the world.” In this situa-tion, the direct fall out of rapid growth has been theinsular growth of the microfinance in India. Despitethe presence of the plethora of institutions, mostoffer the same product, typically with a first cycleloan of Rs.10,000 to be repaid over a period of fiftyweeks. Thus, despite all the ‘we are different’ pos-tures that may be adopted, the race to ‘capture’clients is very clearly visible. This race has stifledinnovation and has ensured that the customer’sneeds are simply not the basis for the products andservices offered by MFIs. It is for this reason thatfrom the villages of Andhra Pradesh to the Gangeticbelt of UP, and whether clients are in remote ruralvillages, urban settlements or metros, everyone isbeing offered the same product irrespective of hisor her needs.However, one might ask how growth could havestifled product innovation? The answer perhapslies in the operations of the microfinance industry.One of the reasons for the rapid growth of micro-finance has been its simplicity in terms of productsand systems. The moment multi-product offeringsare made, the systems become more complicated.Then the MIS has to be more robust, and risk inoperations grows disproportionately, as does thecomplexity of HR, which requires better-qualifiedstaff and more involved training. Hence, sectoralgrowth has been at the cost of innovation and hasnot factored the clients’ needs.

M E A N I N G L E S S G R O W T H

The growth in coverage of microfinance is limitedto pockets, and MFIs across the country have devel-oped a tendency to congregate in specific areas. It isvery common to find urban and peri-urban settle-ments to have between 10-20 microfinance institu-tions operating within a small geography. This haslead to the problem of multiple lending, which hasraised the issue of client over indebtedness, defaultand strong-arm recovery tactics. On occasions,charges have also been made of client suicide dueto repayment pressures, but this appears to be morea figment of the imagination of the vernacular pressthan corroborated by any evidence. Hence, multi-ple lending is a well-known phenomenon and thesector has continued with an ostrich-like attitudeto the problem. Despite evidence from across theglobe, no efforts have been made to address theshortcomings of the group-based lending productand collection methodology, which remains almostexactly as it was when imported in the late 1980s.

C O N C L U S I O N

Overall, the need for microfinance in India cannotbe understated. The government and its pro-grammes aimed at bringing about financial inclu-sion, can never hope to address the needs of thelarge number of poor in the country. Hence, therole of private sector microfinance whether in ‘for-profit’ or ‘not-for-profit’ formats will remain.However, any business which forgets its client can-not have a bright future. In the desire to grow atdouble digit (and even triple digit!) rates, themicrofinance sector may have forgotten the raisond’être for its existence – its clients. Adopting aclient-responsive approach, coupled with ethics-based transparency, could take this sector togreater heights and fulfil the very strong needs ofpoor people in India. ©

—————1 The early 1990 saw NGOs beginning to offer credit services inaddition to other social development programmes that werealready in their repertoire such as education, women empower-ment, water and sanitation etc.

2 The non-banking company format provides oversight ofthe Company Law Board as also the Reserve Bank of India.

3 Sriram, M.S., “Commercialisation of Microfinance inIndia: A Discussion on the Emperor’s Apparel”, in W.P. No.2010-03-04, IIM Ahmadabad, March 2010.

4 State of the Sector Report 2009.5 State of the Sector Report 2009.6 Sriram, M.S., “Commercialisation of Microfinance in

India: A Discussion on the Emperor’s Apparel”, in W.P. No.2010-03-04, IIM Ahmadabad, March 2010.

7 The Bharat Microfinance Report, Side by Side 2009reports an average return on equity of 25.88% (Table 4: Operatingand Financial Summary of 69 MFIs: 11).

a b


A N T O N S I M A N O W I T ZQ U A L I T Y M I C R O F I N A N C E :

S U C C E S S F U L C L I E N T S A N D I N S T I T U T I O N S

This paper assesses the best ways of dealing with thecurrent financial crisis and balancing people needs. Theauthor claims that microfinance institutions (MFIs)should act to ensure both quality and responsible lend-ing, and their main focus is responding to clients’ needs.Microfinance is not only about lending and collectingmoney back, but is a practice with an added social value.There should be an increasing awareness in MFIs of theneed for a socially targeted service, which includes bothpositive social and economic goals. A successful MFI isone that ensures quality and responsible lending to peo-ple in need of financial aid. There is an estimated 2.5 bil-lion with no access to basic financial services. The financial crisis and the recession in the turn of thecentury are revealing the inadequacy of the system andthe need for changes towards more responsible lendingpolicies and practices. The client’s ability to repay a loanshould be supported by institutions tailored to theirneeds. Instead of pushing for competition and highrates, the MFIs should focus more on building a reliablerelationship between the client and the institution. Thecore advice is for client protection to be implemented.

M A L C O M H A R P E RMICROFINANCE AND THE PRESERVATION OF POVERTY

Microfinance was born with the purpose of giving sup-port to millions of indigent people around the world,acting as a force for good. Nowadays, it continues toexpand its services but it has been acting both for goodand for bad, creating an illusion of redemption fromimpoverishment, which turned out to be more a viciouscircle than an actual aid.The author draws out some of the ways in which MFIs con-tribute to the perpetuation of poverty by acting as a realbusiness whose ultimate aim is to make a profit. He alsoindicates how to reduce the bad effects of this situation.The target clients are mainly women, as they are more reli-able in terms of households, child-care and savings protec-tion, and tend to put every effort into repaying the debt bythe required time. However, women tend to be less empow-ered than men, from a physical, economic and social pointof view, thus giving them credit makes them stronger.Even though microfinance claims to be able to reach thepoorest of the poor, it has nevertheless its own interest inmaintaining poverty. Moreover, it marginalises thosealready in desperate situations by forcing them into quickrepayments. However, most people drop out in duecourse because, lacking the knowledge of budget adminis-tration, they are unable to save enough to repay the loan.The psychology of micro financing is based on the depen-dence of its clients, and by forcing them to remain con-tinuously in contact with the institutions. NGOs andother organisations give advice on day-to-day planningand help improve confidence and know-how.

J E N N I F E R M . B R I N K E R E H O F FMAXIMIZING THE EFFECTIVENESS OF MICROINTERPRISE

DEVELOPMENT:THE PARTNERSHIP OPTION

The author elucidates three ways that developmentorganisations can reduce poverty: 1) by remaining as spe-cialised and as focused as possible to their missions andcore values 2) developing programmes linked to multi-sectoral applications and 3) establishing partnership withother organisations to explore different options.In particular, the partnership is useful because it allows coor-dination and a mutual strategic direction to reach strongmutual goals and objectives. The most effective organisationsshould combine three governance mechanisms simultaneously

to succeed in their approach: by dealing with the market, andtaking a bureaucratic and cultural approach. Culture in par-ticular, can become the glue that bonds different actors,ensuring a winning strategy. Reliance on culture is one of thekey necessities for an alliance to work, along with commit-ment to the same mission, knowledge of the technical natureof the issue, fluid interaction, innovation, creative thinkingand mutual participation. Yet, there are also environmentalconstraints that can play a different role and lead to hostility. FINCA International, Save the Children and World Visionare three main examples of good microenterprise develop-ment through partnering and cooperating to achieve acommon goal. Another type of partnership is thatbetween MFIs and microenterprise providers, through, forinstance, large grants that provide incentives. Partnership can offer a wide range of good positive out-comes, such as achieving the integration of services andoffering expertise and knowledge to meet new chal-lenges, and enabling NGOs and organisations to stay spe-cialised and focused

J O N A T H A N H . W E S T O V E RT H E I M P A C T O F M I C R O F I N A N C E

P R O G R A M M E S O N P O V E R T Y R E D U C T I O N

Muhammad Yunus was awarded the Nobel Peace Prize in2006 for his pioneering approach and sustained effort inaddressing the problem of poverty. In addition to thegrowth of Kiva and other web-based micro-lending organi-sations, microfinance programmes have continued to growin usage and popularity. There are numerous studies thatdemonstrate the tremendous successes of such programmesthroughout much of the underdeveloped world. However,the universal effectiveness of microfinance institutions inalleviating poverty is still being debated. Much of the evi-dence cited for the successes of microfinance and microcred-it are merely anecdotal or involve in-depth case studyapproaches. These provide vivid examples and rich details ofthe impact and effectiveness of specific programmes in spe-cific locations at a specific time, but generally fail to achievea more rigorous standard that would allow for research find-ings to be widely generalised. Some more rigorous studieshave been conducted and more are surely to follow, but inthe meantime, NGO leaders and government policy makersmust exercise caution and restraint in applying the microfi-nance approach universally as a means of alleviating poverty.Finally, this article proposes areas for future directions in thecontinued research of microfinance programmes.

S I M O N A S A P I E N Z AM I C R O F I N A N C E Y E S T E R D A Y ,

T O D A Y A N D T O M O R R O W

The author considers the traditional features of microfi-nance and microcredit and identifies a new definition ofmicrofinance in relation to the different characteristics ofsupply and demand. She illustrates a possible future sce-nario for the microfinance market characterised by strongercooperation among stakeholders, international donors,governmental bodies, both national and local, financialintermediaries, NGOs and MFIs. Each using its respectiveskills and institutional objective can play a crucial role infostering the effectiveness of microfinance programmesand in supporting ethical sustainability.

A N A T J A Y A N T N A T UM A R K E T S T R A T E G Y D E V E L O P M E N T A N D 3 R D

G E N E R A T I O N M I C R O F I N A N C E I N I N D I A

Microfinance in India has passed and reached three dif-ferent stages. The first took place in the 1990s, with theSHG-bank linkage model, and the second with MFIs whoacted as intermediates between social and financial sys-tems. Finally, most of the MIFs have adopted the Joint


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Liability Groups (JLGs) methodology to achieve rapidgrowth. Yet, many of those who follow this new trendare losing sight of the original aim and are shifting theirfocus to profit rather than clients’ needs.This shift will bring a tectonic effect, creating a third gen-eration of microfinance institutions (3G-MIFs). The maindifference from the previous generations lays in their long-term market strategy. 3G-MFIs will operate through a fulland long-lasting spectrum of financial needs, and they willtry to focus more on the advantages for their clients.Moreover, they will add new services, such as those relatedto food supply, education and health assistance. Since clients have the right to choose the best institutionfor their own needs, MFIs will need to adapt themselvesto client-needs rather than business-needs, thereby pro-ducing a tectonic shift in the market.

A L B E R T O B R U G N O N IA S H A R I A H - C O M P L I A N T M I C R O F I N A N C E F U N D :

A M U C H N E E D E D T O O L

Available evidence suggests that a strong pent-up demandfor Islamic microfinance products exist across the Muslimcountries. A number of market studies show potentiallystrong demand in Jordan, Algeria, Yemen, Syria, Indone-sia, amongst many other OIC countries. Yet Islamic micro-finance instruments are sporadically used, leaving thebrunt of alleviating the social problems of the Ummah tocharity and welfare traditional organisations. It is suggest-ed that a more structured approach with the use of themodern financial tools, as experienced by the conventionalsector with the use of mutual funds, should add credibilityto the Islamic finance proposition and help eradicatingpoverty in the Muslim world.

M A N J O K . S H A R M AG R A H A M A . N . W R I G H TT I M E T O G E T B A C K T O B A S I C S ?

The nature of MIFs has changed over the years, evolvingfrom an NGO towards a business-centred approach. Ithas now reached the status of an ’industry’ and it hasbecome part of the financial service system.This is mainly due to the participation of for-profittrusts in the contribution of the MFIs. For-profit trustsdisappeared or reduced in size over the years, leavingtheir members in the position of sharing the growth andreturns amongst themselves, and thus introducing abusiness-oriented approach. This way of dealing withthe issue worsens an already unclear situation, leadingtowards a lack of transparency and ethical concerns.With the emergence of a for-profit orientation, the MFIswere able to lower costs and increase the margins. In India,this brought private equity (PE) actors into play. Then, theconsequent growth and gain within the institutions thanksto PE made clear that profit became the goal in itself, andthe clients’ needs were put aside. Moreover, MFIs, hopingto make the most of the profit, have being widely spreadacross specific areas of the country, even in very small geo-graphical zones. Overall, there is a high need for MFIs inIndia, especially because its government programmes willnever be able to address the population as a whole. How-ever, those institutions need to bring the role and needs ofthe client to the forefront otherwise they will not face abright future. By adopting a more client-centred approach,both the poor and the overall sector of microfinance insti-tutions could benefit from greater results. ©

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S P A N D A J O U R N A L I , 2 /2 0 1 0 | m i c r o f i n a n c e

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Spanda Journal | Microfinance: The Way Ahead