Microfinance: Reaching Out

Continuing the series of articles on Microfinance, Hii Dunia using the case study of the Bolivia, the poorest country in South America and its principle Microfinance Institution BancoSol looks at the challenges facing such organisations as they begin to expand and grow.

There are both positive and negative implications of the rapid growth seen by many Microfinance Institutions (MFI's) in recent years. The growth of Microfinace projects can certainly have positive implications. The first and foremost is that growth is the main mechanism for improvement of one of the key criteria for success in Microfinance: Outreach.

Using the example of the Bolivian Bank BancoSol (as discussed in the article here) outreach potential can be seen to vary. Many think that because of its more recent status of that of a regulated financial institution it is forgetting its primary goal, that of poverty alleviation. That it has in effect succumbed to what can be described as ‘mission drift’. Though the bank is in a period of consolidation, the growth in its portfolio has been remarkable.

It is important to bare in mind while considering Outreach the full spectrum of potential that Microfinance has. It is more than just the lending of money in the hope of the client receiving higher rates of return with which he is able to pay back and then keep a profit for himself. Microfinance can give access to education and health and can provide services and loans for events like funerals and weddings.

The average size of a loan from BancoSol is just over one half of the Bolivian per capita Gross Domestic product. However some observers argue that the ‘poorest of the poor’ are still not reached. This may require changes in the loaning technologies of the bank if this situation is to change. BancoSol stipulates that as a precondition a potential client is running an established business for at least a year.

The quality of Outreach with many MFI’s is affected by group lending technologies, there are additional transaction costs that do not exist when a client applies for an individual loan. The monitoring also required for group loans increases the costs. This then is felt by all the group members, however it is still better value for them than many of the established banks in Bolivia.

Incentives offered to clients also have an effect on the outreach and the take up of financial services. Punctuality incentives for example are a common incentive offered by MFI’s. Those in Bolivia are no exception with BancoSol monitoring the clients repayment schedules. Therefore there is no need for a representative from the bank to visit a client if he or she or indeed a group of borrowers have been punctual with their repayments. Someone need only be dispatched if a problem has been detected. These simple procedures practised by the bank have the effect of lowering transaction costs.

With the example of BancoSol it is able to increase Outreach because of reducing 'red tape ' surrounding the issuing of a loan. The joint liability that is enacted when a group loan is taken does not however guarantee repayment.

The strength of the relationship amongst those taking a loan is paramount. Loan arrears with BancoSol remain low but as the successful outreach of the bank demonstrates the constraints of the group lending technology on which much of it has relied up to this point. As clients stay with the bank and they progress with the loan taking and repayment they may begin to expect or demand a quality of service that is not present in the group lending framework. This though is perhaps a sign that they have progressed far enough to transfer their business to some of Bolivia’s mainstream financial institutions.

The role BancoSol plays in its clients lives must not be overlooked when assessing its outreach potential. The personalised service and long term connections represent a powerful incentive for the repayment of loans. Importantly there are also a number of mechanisms employed by MFI’s the world over. The most common is one that is used a great deal in Bolivia, ‘group lending’ and is tried by many MFI’s in slightly different guises.

Though not thought of as being significant enough by some;

“Its role has been exaggerated: group lending is not the only mechanism that differentiates Microfinance contracts from standard loan contracts”. Jonathan Morduch

‘Dynamic incentives’ is another mechanism whereby loans made to borrowers increase as the borrower proves himself or herself able to repay. Because there remains the risk of defaulting, it is best to offer Dynamic incentives in rural areas where people are less likely to be transient and where households don’t simply come and go. This then is an important possibility for the lending of Microfinance in Bolivia. Though the focus is often on urban areas because of the build up of population it is important to consider that the potential impact of credit access to those in rural areas could be very large indeed. This would no doubt have positive repercussions on those who have relocated to the cities and may start to have the effect of reversing some of the migration that has been observed in Bolivia for example in recent years.

Concern over ‘mission drift’ is identified by many authors as a prime factor in preventing MFI’s from reaching the poorest of the poor. Mark Shreiner whilst writing in the Journal of Development points to three reasons why mission drift may occur.

1) Banks can prevent repayment and then hinder social effectiveness.

2) Without subsidised costs, wider scope of clients cannot be served to the resulting wider costs. This then in turn hinders growth in the banks portfolio.

3) Private stakeholders in the bank may simply be unconcerned with the Social Mission of any NGO/Bank.

The group loan feature of BancoSol’s financial practice ensures that loyalty to the bank stands strong and it can face much competition. This may not be the case for many smaller MFI’s operating in Bolivia, who lacks the infrastructure of BancoSol.

BancoSol cannot any longer call upon subsides if needed. However the depth of its outreach seems to so far ensure higher interest rates.

BancoSol is still largely owned and administered by NGO’s and overseas based development banks. 75% of the shares in BancoSol are in the hands of NGO’s and Donor organisations, Bolivian businessmen with significant political clout make up most of the remaining 25% and so it has of yet not had to adhere to any proponents of stringent market forces.

The growth and outreach of BancoSol much like that of the Grameen Bank can be viewed as a logical evolution. An adaptation of a financial institution to the context in which it found itself. In this case it is Bolivia, a country that despite economic setbacks had at least a established banking system and one which adhered to internationally recognised financial practice. For MFI’s in Bolivia and for BancoSol in particular the change from NGO status is compliant in many ways to their social aim of providing an effective tool in the fight against poverty. They are on balance as we have seen a more effective weapon than a regulated bank.


Links & Resources:

Economics and Sociology - Claudio Gonzalez-Vega et al - 'BancoSol: The Challenge of Growth for Microfiance Organizations' (Full Paper)

Hii Dunia - Previous articles on Microfinance.

Journal of Economic Literature - Jonathan Morduch - 'The Microfinance Promise' (Full Paper)

Journal of International Development - Mark Schreiner - 'Aspects of Outreach: A Framework for Discussion of the Social Benefits of Microfinance' (Full Paper)