Microfinance Services

Microfinance is the provision of financial services to low-income people. It refers to a movement that envisions a world where low-income households have permanent access to high-quality and affordable financial services to finance income-producing activities, build assets, stabilize consumption, and protect against risks. Initially the term was closely associated with microcredit—very small loans to unsalaried borrowers with little or no collateral—but the term has since evolved to include a range of financial products, such as savings, insurance, payments, and remittances.

Microfinance institutions and other financial service providers have worked over the past decades to develop products and delivery methods to meet the diverse financial needs of low-income people. For example, unlike other forms of lending, microcredit loans use methodologies such as group lending and liability, pre-loan savings requirements, and the gradually increase in loan sizes to evaluate clients’ credit worthiness. Microfinance providers today continue to improve their understanding of the financial needs of their target clients and tailor their products and methodologies accordingly.

What is financial inclusion?

The goal of financial inclusion is to develop financial markets that responsibly serve more people with more products at lower cost. Financially inclusive markets comprise a broad, interconnected ecosystem of market actors and infrastructure delivering financial products safely and efficiently to low-income customers. These market actors may include banks, financial cooperatives, e-money issuers, payment networks, agent networks, insurance providers, microfinance institutions, and more.

Financial inclusion efforts today build upon the work of microfinance providers over the last several decades. What began as the provision of loans to poor people for the purpose of building microenterprises has evolved into a global effort to provide poor people with access to a range of financial products and services. Research and experience demonstrate that, in addition to using credit, low-income people save, make payments, use insurance, and make use of a variety of other tools to manage their complex financial lives. Financial inclusion efforts seek to make these and other products available to everyone in a safe, cost effective, and convenient manner.

Who are microfinance clients?

Typical microfinance clients have low incomes and are often self-employed in the informal economy, conditions that together typically deny them access to banks and other formal financial institutions. They commonly run small stores or street stalls, create and sell items they make in their homes, and in rural areas, microfinance clients may be small-scale farmers and those who process or trade crops and goods.

Microfinance clients are often just below or above the poverty line, commonly defined as earnings of US$1.25 a day, and women constitute a majority of borrowers. Over the past decades, financial institutions have been developing a range of products to meet the diverse needs of this broad and underserved market.

What kinds of institutions deliver financial services to poor clients?

Poor people need many kinds of financial products and services and there is a growing range of organizations working to reach them with savings, insurance, transfers, and credit services.

In addition to traditional operators, such as microfinance institutions, credit unions, cooperatives, and banks, other entities, including mobile network operators, are using technology to develop new delivery methods to bring these services to the poor, sometimes in partnership with existing financial institutions.

What financial services do poor people use?

One of the realities of living in poverty is that income can be irregular and undependable. People living in poverty need to access a wide range of financial products and services that are tailored to their circumstances. Financial services can help people build assets through savings or financing income-generating activities, and can make it easier for them to manage shocks, such as medical emergencies, death, theft, or natural disasters. Research captured in?Portfolios of the Poor ?shows that, despite many hurdles, even people surviving on US$2 a day strive to save, get credit, take out insurance, and make payments and transfers using whatever means they can.

The problem remains that low-income people pay high costs and sometimes rely on insecure, unpredictable, and unscrupulous options to access basic financial products and services, which is why the financial inclusion movement is striving to encourage the delivery of a full range of financial products at fair prices and without the risks poor people face today.

What is mobile banking?

Mobile banking refers to financial transactions conducted over a mobile device. Mobile banking has the potential to reach more people, at a lower cost, and with increased convenience than traditional “brick and mortar” banking services that rely on fixed branches.?

With the rapid global expansion of mobile technology, mobile banking is helping vast numbers of previously excluded people access financial services. Mobile network operators, governments, and financial institutions, ranging from large commercial banks to microfinance institutions, recognize and have begun to exploit the potential of mobile banking.? A number of governments and their central banks have also embarked on “cash-lite” policies to reduce the use and, therefore cost, of cash in their economies.

Researchers are studying successes and failures of mobile banking to understand the market forces, business models, and ecosystem requirements to support successful mobile banking deployments elsewhere around the world.

Why are interest rates higher in microfinance loans than in traditional banking?

Small loans are more expensive to process than large ones because they take longer to process. Without employment history or collateral, microfinance loans require a more hands-on, time-intensive assessment to determine creditworthiness. Microfinance institutions (MFIs) usually send a representative to visit the client as part of this process, making the process even more challenging and costly in remote or sparsely populated areas. Once a loan is approved, MFIs often send loan officers to disburse loans and collect payments in person, which also adds significant expense when compared with the way traditional banks operate. MFIs have to charge rates that are higher than normal banking rates to cover their costs and keep the service available.

The good news is that technology and new business models are creating opportunities to reduce costs and reach more people. For example, banks and MFIs can use mobile money and agent networks to disburse loans and collect payments instead of sending loan officers to remote areas to make these transactions. These types of innovations help to reduce the cost of doing business with poor clients and, in turn, can reduce charges to clients.

What is the government’s role in supporting financial inclusion efforts?

Governments support financial inclusion in three key areas. First, they set the rules and properly regulate the environment for financial inclusion, balancing the drive to bring financial services to the poorest with measures to protect consumers. Second, governments can promote infrastructure, either financially or by incentivizing private sector investments, to support the expansion of financial services. Such infrastructure might include mobile payment systems, point-of-sale networks, or credit registries, for example. Third, governments can support financial inclusion by driving transaction volume via electronic deposits of government-to-people payments (e.g., social payments, wages, or pension payments) into financially inclusive accounts. In these three ways, governments can play a crucial role in supporting financial inclusion.

What consumer protective measures exist for clients?

Concerns about the impact of excessive interest rates, abusive lending practices, and over-indebtedness among poor borrowers have led to increased attention to responsible finance and consumer protection measures. Three main areas of protective measures have emerged:

• Consumer protection, regulation, and supervision to ensure that customers are treated fairly and appropriately, and that they understand the implications of their actions;
• Improved standards and codes of conduct within the industry, with an emphasis on consistency;
• More informed consumers, so that they can become more responsible for their own financial welfare.

The microfinance community has responded with multifaceted approaches to focus on consumer protection and the social imperative behind financial inclusion and microfinance. The?Smart Campaign , the?Social Performance Task Force (SPTF) , and True lift each address different but complementary aspects of consumer protection and social performance.

The investment community has responded by creating a responsible investment initiative. The?Principles for Investors in Inclusive Finance (PIIF) ?provide a framework for responsible investment in inclusive finance.

What tools are used to measure the impact of financial inclusion efforts?

Given the amount of money and effort spent on financial inclusion globally, it is important to go beyond anecdotal evidence and measure the impact of these initiatives. Understanding whether programs are helping people, who they have helped, and why they worked can help improve program design to achieve greater impact.

Several approaches are used to evaluate a program’s impact. The simplest one is program evaluation that looks at a set of indicators to assess the client’s well-being before and after access to financial services—often referred to by researchers as the intervention. The drawback to this method is that it cannot determine causation, so changes observed may or may not be the result of the intervention. Other methods, including randomized control trials (RCTs) and quasi-experimental assessments, go beyond program evaluation to develop a causal link between the intervention and changes in the well-being of people it sought to help. RCTs and quasi-experimental impact assessments can provide the most accurate data on impact, but they are complicated and expensive to conduct and are typically led by academics or those with specific training in impact assessment.