Offering financial services to poor people in developing countries is expensive business. The cost is one of the biggest reasons why traditional banks don´t make small loans, the resources requierd for a 50$ loan is the same as for a 1000$ loan.
MFIs also have big personnel and administration costs. Field staff managers must perform village surveys before entering a village, conduct interviews with potential borrowers, educate the borrowers in credit discipline, travel to the villages every week to collect interest and distribute loans and control that the loans are being used for the given purpose.
The microcredit loan cycles are usually shorter than traditional commercial loans with terms from typically six months to a year with payments plus interest, payed weekly. Shorter loan cycles and weekly payments help the borrowers stay current and not become surprised by large payments. Clearly the transaction-intense nature of weekly payment collections, often in rural areas, is more expensive than running a bank branch that provides large loans to economically secure borrowers in a metropolitan area. As a result, MFIs must charge interest rates that might sound high.
In order to be able to lend out money, the microfinance institutions must in addition borrow from the traditional finance sector with commercial perspective. There´s always about 1-2% loss on loans due to people not paying back. To be able to expand business the MFIs must also make some profit, at least 1-2%. All in all it´s easier to understand why the MFIs charge their customer interest rates which in first sight might appear high. With a growing market, better economics of scale and increasing efficiency the cost will reduce and lower interest rates are able.
For a financial institution to scale and remain sustainable, at a bare minimum it has to cover its costs. A large bank can charge lower rates in order to recoup its costs. Because of smaller loan size and more transactions, the MFI has to charge higher minimum rates.
Data from the MicroBanking Bulletin reports that 63 of the world’s top MFIs had an average rate of return, after adjusting for inflation and after taking out subsidies programs, of about 2.5% of total assets. This lends to the hope that microfinance can be sufficiently attractive for investors, as well as the mainstream in the retail banking sector.
Typical microcredit products look like this (the numbers are only hypethetical):
|Income Generation Loan (IGL)||Income generation, asset development||50 weeks loan paid weekly||12.5% (flat) 24% (effective)|
|Mid-Term Loan (MTL)||Same as IGL, available at middle (week 25) of IGL||50 weeks loan paid weekly||12.5% (flat) 24% (effective)|
|Emergency Loan (EL)||All emergencies such as health, funerals, hospitalization||20 weeks loan||0% Interest free|
|Individual Loan (IL)||Income generation, asset development||1-2 years loan repaid monthly||11% (flat) 23% (effective)|
The Income Generating Loan is used for a variety of activities that generate income for their families. Clients submit a loan application and based on approval receive the loan after one week. Loans are paid in 50 equal, weekly installments. After completion of a loan cycle, the client can submit a loan application for a future loan. The approach with smaller short-term loan is to avoid long-term economic problems with bigger loans.
The Mid Term Loan is available to clients after 25 weeks of repaying their IGL loan. A client is eligible for a MTL if the client has not taken the maximum amount of the IGL. The residual amount can be taken as a MTL. The terms and conditions of the MTL are otherwise exactly the same as IGL.
The Emergency Loan is available to all clients over the course of a fiscal year. The loan is interest free and the amount and repayment terms are agreed upon by the MFI and the client on a case by case basis. The amount is small compared to the income generating products and is only given in times of dire need to meet expenses such as funerals, hospital admissions, prenatal care and other crisis situations.
The Individual Loan is designed for clients and non clients that have specific needs beyond the group lending model. Loans are given to an individual outside of the group lending process. Amounts are typically higher than that of the income generating loan and repayments are less frequent. Applicants must complete a strict business appraisal process and have both collateral and a guarantor.
Microfinance is not panacea from all troubles, this also means that not any poor person can obtain the loan. In particular, representatives of very poor population, lacking stable income, living by means of chance earnings, and particularly having debts (in relation to community facilities, relatives, friends, etc…) cannot be clients of microfinance, since in case of microcredit non-repayment they will have more debts, becoming poorer. For such people special programs of social assistance are needed, which are able to support main needs of people living in the poorest dwellings, lacking garments and food.
There is some restrictions regarding what the money is used for. Usually micro credits can´t be used for the purposes like:
- Payments of other loans or other debts;
- Production of tobacco and liquor;
- Forming turnover capital of trade and intermediary business;
- Organization or purchasing products for gambling or entertainment services for the population;
- Establishing trading points;
- Purchase of property that´s not used for business.
In the microfinance sector there´s other services expanding as well. The poor need, like all of us, a secure place to save their money and access to insurance for their homes, businesses and health. Microfinance institutions are now innovating new products to help meet these needs, empowering the world’s poor to improve their own lives. Products common used in the microfinance sector today is:
- Micro savings – A possibility to save money without no minimum balance. Allows people to retain money for future use or for unexepected costs. In SHGs the members save small amounts of money, as little as a few rupees a month in a group fund. Members may borrow from the group fund for a variety of purposes ranging from household emergencies to school fees. As SHGs prove capable of managing their funds well, they may borrow from a local bank to invest in small business or farm activities. Banks typically lend up to four rupees for every rupee in the group fund;
- Micro insurance – Gives the entrepreneurs the chance to focus more on their corebusiness which drastically reduces the risk affecting their property, health or workingpossibilities. The is different types of insurance services like life insurance, property insurance, healt insurance and disability insurance. The spectrum of services in this sphere is constantly expanded, as schemes and terms of providing insurance services are determined by each company individually;
- Micro leasing – For entrepreneurs or small businesses who can´t afford buy at full cost they can instead lease equipment, agricultural machinery or vehicles. Often no limitations of minimum cost of the leased object;
- Money transfer – A service for transferring money, mainly overseas to family or friends. Money transfers without opening current accounts are performed by a number of commercial banks through international money transfer systems such as Western Union , Money Gram, and Anelik. On the surface they may seem like small money transfers, but when one considers that such transactions take place millions of times around the world each week, the numbers start to become impressive. According to the World Bank, the annual global market for remittances – money transferred home from migrant workers – is around 167 billion US dollars. The estimated total is closer to 230 billion dollars if one counts unregulated transactions. Remittances are also an important source of income for many developing countries including India, China and Mexico, all of which receive over 20 billion dollars each year in remittances from abroad.