Microfinance

By Whitni Thomas
Head of Access to Finance
new economics foundation (nef)

With 2005 as the United Nation's International Year of Microcredit, the subject has generated a lot of interest recently. Microfinance organisations, or MFIs as they are often called, provide financial services to people on low incomes who do not have access to credit and other financial services. While the services and products vary, MFIs typically make small loans (of around $100) to poor people for short periods of time. The premise of microcredit is that people who have traditionally been excluded from the banking sector because of lack of income or collateral also have credit needs. These needs either go unmet or are met at the exorbitant terms set by moneylenders or loan sharks. For microentrepreneurs, not being able to access credit can mean not being able to buy inputs at wholesale price because of lack of working capital or not being able to invest in even the smallest assets such as buying a goat or a stall at the market.

Proven model

Contrary to the prevailing belief thirty years ago, the microcredit model has demonstrated that poor people can, and do, repay loans. Although microcredit came to prominence in the 1980s, experiments in microcredit started thirty years earlier in Bangladesh and Bolivia. One of the most well-known MFIs in the world is the Grameen Bank, started by Muhammed Yunnis in Bangladesh. Since the early days of microcredit, the industry has come into its own. Microcredit's scale has grown tremendously, but recent estimates suggest that the potential market for microfinance is $300 billion, compared with current available loan capital of $4 billion. While it is difficult to quantify, recent estimates put at 3 billion the number of people of working age that lack access to financial services. Indeed, in many developing countries the number of people excluded from the mainstream banking sector is high, reaching 50% in Brazil, for example.

The microcredit industry has shown that poor people are bankable and can be offered credit in a sustainable manner. On the back of the industry's success, some commercial banks have followed MFIs' lead and partnered with MFIs to reach out to lower income customers. In other markets, microcredit provision is still dominated by non-profit providers. There remains an inherent tension between the social goals of microfinance (inclusion for the poor) and the financial ones (the need for sustainability of the MFI). The need to balance the two is what makes MFIs an excellent example of social businesses, creating social benefits while also generating a financial return on investment. The tension of these dual objectives has generally been good for the sector and has spurred innovation and more efficient delivery models. Many MFIs have branched out to offering other financial services for their clients such as insurance products.

The UK microfinance sector operates in a slightly different context than in other countries. British microfinance institutions identify with the community development finance sector in the UK. While they share a common purpose to fill gaps in access to finance for the socially or economically excluded enterprises or individuals, community development finance institutions (CDFIs) in the UK have a range of different operating structures, products and target groups than do most microfinance institutions. Access to finance in the UK is more broadly understood than simply microfinance or start-up finance. Organisations may focus on different market niches, such as: small loans to previously unemployed female entrepreneurs; cultural or creative industry enterprises; business start-ups in deprived areas; or socially driven organisations ('social enterprises'). While some institutions specialise in microfinance loans, the sector as a whole consists of a range of product offerings to address financial exclusion and to channel finance to deprived communities.

There are various ways to support microfinance in developing countries as well as in the UK. The manner in which the support is structured will vary depending on the amount of money the donor has to invest, her motivations and risk profile. A donor could structure her investment as a loan, an equity investment or a donation. Some MFIs look for social investors who are interested in loaning money for the MFIs to on-lend. For example, one way to loan money to microfinance initiatives is to invest in a Shared Interest/Oikocredit microcredit bond.

Investors might choose to structure their investment in microfinance as an equity investment. One type of equity investment would be buying shares in one of the MFIs/CDFIs that are registered as industrial and provident societies. Some of these investments would also qualify for Community Investment Tax Relief. More information is available on the website of the Community Development Finance Association (CDFA). Most CDFIs focus on lending to small businesses and to social enterprises. Examples of CDFIs in the UK that focus on lending to sole traders/microentrepreneurs are Street(UK), The Women's Employment, Enterprise & Training Unit (WEETU), and Fair Finance in London.

Of course MFIs also accept donations, and an individual interested in supporting microfinance can donate funds to them as well. There are normally higher costs associated with making small loans to hard-to-reach people, so many MFIs also rely on donations and grants as part of their funding stream, particularly to fund operating costs.

MIX is a global information exchange for the microfinance industry. The MIX Market strives to facilitate exchange and investment flows, promote transparency and improve reporting standards in the microfinance industry. MIX is an excellent resource for investors and donors looking to support microfinance in developing countries. There is little information about microfinance in developed countries. For more information on microcredit in Europe and potential European MFIs to invest in, please see the European Microfinance Network on www.european-microfinance.org.

More information on microcredit is available from a number of resources, including the World Bank's Consultative Group to Assist the Poorest (CGAP).

Whitni Thomas is head of Access to Finance at nef. She leads nef's research and consultancy work focussed on improving access to finance for financially excluded individuals as well as socially driven businesses. Whitni is also concerned with broader issues surrounding the responsibility of banks to meet the needs of all. She has a particular interest in how to meet the financing needs of fair trade companies. Whitni is a board member of the European Microfinance Network and on the steering group of the Campaign for Community Banking Services.

nef (the new economics foundation) is an independent 'think-and-do' tank which aims to improve quality of life by promoting innovative solutions that challenge mainstream thinking on economic, environment and social issues. nef has an exceptional record of economic and social innovation, and has established itself as a leading UK research and policy organisation in the area of social enterprise and access to finance. For more information, visit www.neweconomics.org.