2010 Publication by Pfeiffer University Marketing & Communications

BANKING ON THE FUTURE: EXPLORING MICROFINANCE AS SERVICE October 1, 2010 PROCEEDINGS Sponsored By:

Francis Center for Servant Leadership Pfeiffer University

BANKING ON THE FUTURE: EXPLORING MICROFINANCE AS SERVICE October 1, 2010 PROCEEDINGS

Published by Pfeiffer University Library Dr. Rosemary E Minyard, editor Copyright owned by Pfeiffer University

ISBN – 13: 978-0-692-01338-0

ALL RIGHTS RESERVED No part of this work covered by the copyright hereon may be reproduced or used in any form or by any means – graphic, electronic, or mechanical, including photocopying, recording, taping Web distribution or information storage and retrieval systems, or any other manner – without the written permission of the publisher. For permission to use this material submit a request to microfinance@fsmail.pfeiffer.edu

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

Table of Contents Preface

iii

Introduction: Microfinance as Service

Bios

THE PAPERS CHAPTER I……………………………………………………………….........MICROFINANCE AND FAITH “How Microfinance Transforms the Materially Non-Poor” Todd Engelsen, President, PEER Servants

CHAPTER II……………………………………………………COORDINATION WITHIN MICROFINANCE “The Needed Coordination with Microfinance” Roldolfo Beazley, Board member of Mujeres 2000 CHAPTER III…………………………………………………………MICROFINANCE IN LATIN AMERICA “The Role of Government in Latin America Microfinance Industry” Veronica Trujillo Tejada (Ph.D. candidate, Salamanca University

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

PREFACE

Even though the debate on microfinance is very broad, no one should shy away from participating if they are inspired by what it does and what it can accomplish. By the same token no one should think the microfinance approach is the answer to and can solve all the problems of systemic poverty. But once again we have reached out to a seemingly disparate group: practitioners, academics and faith based institutions in microfinance with the view towards obtaining a better understanding of what can be done and how we might do it. This year we take a slightly different approach and explore microfinance not only from the perspective of those being served but also from the perspective of those who want to serve. This is very important to an institution such as Pfeiffer because our mission is Servant Leadership. We are not only looking for projects to serve on and undertake but also for ways to inspire those who want to serve. With this added perspective we are beginning to develop our voice in the debate and we are still open to hearing your opinion about what you think that should be. We also had the pleasure this year of hosting several presentations that contributed immeasurably to the colloquium. Dr. Ken Carter of Providence United Methodist Church in Charlotte, NC, along with his wife, share their involvement in a microfinance project in Haiti that grew out of their work there in health care. Ms. Alice Gasatura, Director of Credit Support, URWEGO

Opportunity Bank in Rwanda came to us from Opportunity International, which is a faith based microfinance (MFI) with projects all over the globe. It was our joy to host Ms. Gasatura because of her first hand knowledge of the power of microfinance in Rwanda. Mr. Joe Mynatt of Grameen America is leading the effort in Charlotte, NC to capitalize a branch of the Grameen Bank. Ms. Mynatt explains how the power of Grameen Bank microfinance can be effective in a place like Charlotte. We urge you to go to the web site to watch the videos and learn about their work. Once again, this publication goes hand in hand with the web site and you can access it by copying and pasting the link below in your browser. All the video presentations, with their discussions and questions from the audience, are there to broaden your understanding. http://www.pfeiffer.edu/academics/undergraduate/2011-microfinance-colloquium/2010-videos In closing I’d like to thank all who helped in putting this colloquium together again, including but not limited to Pfeiffer’s Dr. Rosemary Minyard, Dr. Eunwook Park, Mr. Scott Eisnaugle, Sam Serio of Opportunities International and the Charlotte Symphony Guild. This event continues to be an unqualified success in presenting Pfeiffer University’s concept of microfinance as service. Next year we will offer a new graduate level course entitled Social Entrepreneurship and Microfinance: Leadership for Develop and hope that you’ll continue to be inspired by our work and explore your own interest in microfinance. Dr. Tracy Espy Provost and Vice President for Academic Affairs

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

Introduction This year we have narrowed our focus on microfinance by selecting only three papers which do an excellent job of highlighting the following issues: a) It is not only the recipients of microfinance who can benefit from microfinance but also the givers, b) By collaborating together and using more than one approach microfinance can become more effective and reach a larger number of people, and c) Although much of the work in microfinance is undertaken or supported by governments there is still a lot of work to be done to understand how to make these efforts effective. Todd Engelsen, CEO of PEER Servants (Partnership for Economic Empowerment and Renewal) writes about the impact of microfinance on the materially non-poor and provides unique insights that encourage people to get involved. With examples from his experiences with PEER Servants his stories are not only about receiving but also about giving. This article ignites our thinking on ways that microfinance’s impact might be measured on the donor in the same way as many are trying to measure the effects of microfinance on the recipients. That is important because man is a social animal and more we understand about the interactions of human beings in all contexts the better we can design institutions to meet all of our needs more effectively. For our second selection, Rodolfo Beazley has written about the needed coordination with microfinance. As with anything new, and as effective as microfinance has been, there is a great desire to replicate it in order to increase its impact. This was resulted in disagreements on what might be more effective. Although there is clearly no one size fits all in microfinance there are a couple of over arching themes which are identified in this paper. He puts forth a model on how to integrate those disparate themes operationally in order for microfinance to have a more lasting impact. Finally Veronica Trujillo Tejada and her colleagues from Salamanca University have provided and excellent taxonomy of government intervention in the microfinance sectors of five (5) Latin American countries. The framework for the analysis in this paper is CGAP’s three pillars of governmental actions which lay out a comprehensive scheme for effective government intervention. The descriptions of the programs and their relationships to each other are excellent and they provide much needed background on what is going on in those countries. As they note in the paper there are other sources out there on government regulation in support of microfinance but microfinance is not only about regulation. We encourage readers to explore all of these papers because it is our view is that these various views and implementations of microfinance are related. We ask the question that if we really understood how beneficial microfinance was to the materially non-poor would there not be more microfinance projects in the pipeline? If there could be more coordination among existing microfinance institutions would the impact on poverty alleviation not be greater? As the CGAP framework implies, if governments perform the way the literature suggests shouldn’t the number of microfinance enterprises would be greater? We believe that the more these ideas are explored as an integrated whole the more you’ll be able to appreciate how effective microfinance can be. Dr. Rosemary E. Minyard

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

BIOS Banking on the Future: Exploring Microfinance as Service explored different implementations of Microfinance and included experts on Microfinance from academia, faith based and practicing organizations and focused on the links between the Microfinance and the philosophy of Servant Leadership.

How Microfinance Transforms the Materially Non-Poor Todd Engelsen, President PEER Servants Todd Engelsen: President of PEER Servants (Partnering for Economic Empowerment and Renewal), a Christian microfinance organization serving indigenous MFIs around the world through a network of primarily volunteers. He volunteered with PEER Servants for over 15 years before transitioning to a full-time position in 2004, leaving John Hancock Financial Services, where he had been vice president and actuary. He is a graduate of the University of North Carolina at Chapel Hill. He resides in the Boston area with his wife, Leslie, and family. Todd can be reached at todd.engelsen@peerservants.org. *

The Needed Coordination Within Microfinance Rodolfo Beazley, Board member of Asociación Civil Mujeres 2000 Rodolfo I. Beazley: Board member of Mujeres 2000, an Argentinean NGO that has a microfinance program with experience with the World Bank Group and the Argentinean national government. He is economist from the University of Buenos Aires (Argentina) and holds a master in Economics from the University of San Andres (Argentina) and a master in Social Policy and Development from the London School of Economics (UK). *

Finance For Less Wealthy People: The Role of Government in the Latin America Microfinance Industry Verónica Trujillo Tejada (Ph.D. candidate), Victoria Muriel Patino, Ph.D., Fernando Rodríguez López, Ph.D., Salamanca University

Verónica Trujillo Tejada: A Peruvian lawyer who previously worked in banking, international

trade and administrative law is a doctoral candidate at Salamanca University in Spain. Victoria Muriel Patino and Fernando Rodriquez Lopez are faculty members in the Department of Applied Economics at the university. ix Bios Copyright © 2010 Pfeiffer University All rights reserved For permission contact microfinance@pfeiffer.edu

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

THE PAPERS

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

FINANCE FOR LESS WEALTHY PEOPLE: THE ROLE OF GOVERNMENT IN THE LATIN AMERICAN MICROFINANCE INDUSTRY. Phd. Victoria Muriel Patino, Salamanca University Phd. Fernando Rodríguez López, Salamanca University Verónica Trujillo Tejada

ABSTRACT Finance for the less wealthy people is an important concern all over the World. Both developed and developing countries are increasingly trying to find ways to guarantee access to credit for everyone through the development of the microfinance industry. Governments are eager to play an active part and an important question is what, if any, steps should governments take to help microfinance market? CGAP has summarized these possible actions in the “three Ps” in order to build a comprehensive scheme of governmental action; establishing guidelines of practices for the provision and protection roles and a set of possible actions to analyze the development of the promotion role. We have chosen four Latin American countries, in which the percentage of population served by microfinance institution is higher, and evaluated governmental action in microfinance to determine whether they not only fulfil the guidelines for an adequate provision and protection role but also what have they done in their promotion role.

INTRODUCTION It is widely accepted today that the financial system not only needs to serve wealthy people but also the poor,1 who have through the years paid high interest rates and sustained a fully functioning microfinance industry. Microfinance has provided an alternative source of funding in the financial industry since the 1970´s. Efforts are being undertaken today to try to make the financial system (through microfinance) reach groups that up to now have been excluded. Reaching these excluded people will not only deepen the financial system but also help countries to improve their own development. Therefore, Governments are concerned with how to help or promote microfinance industries. Many different governmental actions have been undertaken and which of them are good or harmful to the industry is an important issue in determining the best role for government in this special sector of the financial system. Analyzing the role of the government in microfinance is difficult. There is no consensus about what should be done, the available theories on this topic are poor and there is not enough information to support strong conclusions. The main aim of this paper is to describe the current state of the knowledge about the role of the government in microfinance, and to analyze the 1

Due to market failure (basically imperfect information, moral hazard and adverse selection) credit markets are wealth constrained, since collateral is often required, as well as risk constrained, since poor people cannot expose their collateral to risk even if they have it (De Janvry and others, 2003). This picture has been partially overcome since the beginning of the Microfinance Revolution because it has opened access to financial services for millions of poor borrowers.

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings experiences in five Latin American countries (those with the highest percentage of population and microenterprises which are clients of Microfinance Institutions) in order to evaluate whether they support or refute mainstream theories on the role of the Government in microfinance. We have used data provided by the Economist Intelligence Unit (2009) in the document “Microscope in the Microfinance Business Environment” and have chosen Bolivia (8% of its population and 44.6% of its microenterprises are clients of microfinance institutions), Ecuador (7.7% of its population, 47.5% of its microenterprises are clients), Nicaragua (6.7% and 58.7%), Peru (5.7% and 31.3%) and El Salvador (4.9% and 35.8%) because of their first ranking positions in the region. This paper is structured in two main parts: in the first one, we will describe the possible actions that Government can take in microfinance (identified as “the three Ps”). The second part will analyse the framework to be applied in order to evaluate Government activities in those countries. I. THE ROLE OF THE GOVERNMENT IN MICROFINANCE: Governments can play many different roles in microfinance, from proving services directly to supervising competition in the market. The paper does not deal with the issues of regulation and supervision because there is a wide consensus about the need for prudent vs. non prudent regulation once the market is big enough. Yet there are few studies about what government should do apart from regulation. Many articles stress the fact that government should have a minimal presence in microfinance (Duflos and Imboden, 2004; Bate, 2007), but there are other studies (Nimal, 2003; CGAP, 2006, 2009; UN, 2006) that call for a much more active role. Following the CGAP, 2 we can sum up these governmental roles in microfinance in three words: Protection, Provision and Promotion (the three Ps). Some of the studies stress how these roles help countries achieve financial inclusion but our specific objective is not to measure or study the financial inclusion in any country but to use the conclusions of these studies3 as guides to construct a theoretical basis structured under the three Ps to analyze what can or should be done by governments in the microfinance industry to achieve their desired results. I.1. Government Provision Role in Microfinance The provision of microfinance services by the government is generally criticized, even though more than 50 countries all over the world do. Government as the direct provider of microfinance is usually considered one of the least efficient policy interventions for achieving sustainable access by the unbanked because this kind of intervention usually combines financial and political objectives creating unfair competition or eroding the payment culture. However it must be stressed that there are some exceptions and several government programs are working successfully in this manner.4 2 CGAP. Government’s role in microfinance: What is the optimal Policy Mix? January 16, 2009. Available on line: http://www.cgap.org/p/site/c/template.rc/1.26.4903/ 3 Namely, we will follow these publications: Helm B. (2006) Access for All. Building inclusive financial systems; CGAP.(2009) Government’s role in microfinance: What is the optimal Policy Mix?; UN. Building Inclusive Financial Sector for Development; and EIU (2009) “Global Microscope about the business environment for Microfinance”. 4 As examples of Government’s institutions successfully performing in microfinance, we can point out the performance of Banco do Nordeste (Crediamigo) from Brazil and BancoEstado from Chile. The paper “Liga de Campeones 2008” (Gehrke M., Martínez

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

Direct government intervention in microfinance results in the same potential problems or solutions whether work directly with people or through second tier institutions or with financial intermediaries. Successful government programs have built a framework of best practices summarized by the following principles: (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix)

Public microfinance institutions must have a well defined mandate must work on commercial principles must have a clear accounting of subsidies must comply with the general legal framework must have managers committed to provide viable financial services to poor clients must thoroughly evaluate their decisions and have the patience to allow growth should prevent political influence in lending practices should not have interest rates so low that they cannot cover their costs, and should have controls in place to avoid fraud within a decentralized structure.

These performance guidelines are necessary to avoid the potential pitfalls. The widespread failure of government actions in financial services has taught us that the main reason is because heavily subsidized activity usually leads to the following problems: a. Political patronage in financial governmental institutions. b. Borrowers do not take their responsibilities seriously and often think the credit is a grant or gift. c. Below market interest rates mean that the lending institutions can not cover their costs. d. Targeting specific sectors regions or populations does not necessarily mean that credit can reach the most dynamic sectors of the economy or, even worse, does not reach the targeted beneficiaries. There is room for direct government provision of microfinance and it can be a successful policy intervention if the public institutions in the microfinance market follow the guidelines above. However a deeper analysis of this topic is necessary as the numbers of governments who are trying intervene in microfinance are increasing and new questions are arising in each specific case. (cf. De Montesquieu, A., El-Zoghbi, M. & Latortue, A, 2008). I.2. Government Promotion Role in Microfinance The promotion role of the Government in microfinance relates to policies which promote financial inclusion. There are indirect promotion tools that benefit industries, even when not specifically directed to microfinance, like the promotion of fair competition or the improvement of the payment system. Also there are direct promotion tools, like the implementation of national strategies for microfinance, the provisions of financial and technical assistance, or the support to the so called priority sector lending. The effectiveness or efficiency of these tools however is not clear, although this does not lead to the rejection of promotion action but a general call to R. and Rond贸n M., 2008) position them in places 2 and 7, respectively, between 100 biggest microfinance institutions in Latin America and in places 10 and 5 in efficiency.

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings research them and the government’s related performance. It will be useful for stakeholders to know which governmental promotion policies are more useful and, prior to these interventions, a good diagnostic assessment would be helpful in identifying barriers to institutional capacity for microfinance in a specific country. In general terms, the promotion role in microfinance reflects the preferential treatment attempted by Governments to correct some failures in the financial markets by providing incentives, subsidies or other actions that affect the way financial service providers compete. Any of these measures can distort the market performance if they are not applied appropriately. Some models of government promotion are: a. Priority Sector Lending: This action requires financial institutions to lend to specific sectors for social purposes and may be the only way for excluded people to access to the financial system. However lending in this type of system is said to force banks away from lending efficiently in terms of risk and return because they are forced to lend to the less creditworthy. b. Regulatory Incentives: Regulatory incentives may be designed to make financial institutions lend to specific communities. At least 8 countries have programs of this type and among them are Australia, Brazil, Canada, India, and Nigeria. The Community Reinvestment Act is one strategy that seems to be effective and has been applied since 1977 in the USA to encourage lending to low income people within a community where the institution operates. But this Act is also criticized because of its high cost for small financial institutions. c. Government Transfer Payments: Because government often transfers payments through bank accounts, these accounts could be used to offer a wide range of services to the beneficiaries with the aim to guarantee financial access and different services. In the United Kingdom, for example, the government makes social security benefits via transfers to the beneficiary accounts and is working with postal services and banks to create special accounts free of charge. d. Matching Deposits: These are special kind of accounts offering incentives to savings (i.e., for continuing education or buying a house) by providing matching deposits in equal or proportional amounts saved by the client to be spent on previously established objectives. e. Subsidies: Because subsidies can be temporary or permanent, transparent or hidden, and can be directed to specifics activities, it is necessary to analyze whether they are efficient and sustainable. “Smart Subsidies” are designed to achieve a clearly defined outcome and to target specific recipients. It is important to evaluate beforehand which subsidies are valuable and which are counterproductive and, once they are established, transparency and performance-based agreements are important things to consider in evaluating their effect and controlling their evolution. f. Mandates: Mandates are designed to encourage and shape retail financial services. Interest rate ceilings and portfolio quotas are the usual type of mandates used. However, since the motivation to serve poor or excluded people should come from within financial institutions experience has shown that mandates are counterproductive most of the time. g. Other Measures: Other measures which are specifically directed to foster financial inclusion include (a) the integration of poor people’s access through the objectives of

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings regulation and supervision and in supervisory practices, (b) the instruction of financial institutions to collect and report data on the usage of financial services, (c) the treatment of microfinance as a business line, (d) the reassessment of the credit risk of the underserved and MIFs, (e) the review of regulatory constraints, and (f) the adjustment of supervisory practices (to simplify them) and the reinforcement of supervisory capacities. Because there are very few examples of analysis of this topic and because of the special circumstances related to their implementation we only will identify where governments have implemented any of these measures and specify into what type their actions fit. I.3. Government Protection Role in Microfinance The role of government as protector is to build trust in the financial system and to resolve any of the asymmetry between clients and financial institutions. Regulation and supervision are fundamental tools to use but must be implemented in such a way to be flexible enough to address new developments in the market without impeding them. The governmentâ&#x20AC;&#x2122;s role as protector is the one which requires greater consensus to achieve and, for the reasons explained, it is important to specify certain guidelines which will achieve the best practices for its performance. There are some government protection actions that are indirectly related to the microfinance sector, like providing macroeconomic stability or capital market development, but our analysis will be focused in the guidelines created that are directly related to microfinance, like specific regulations for both microfinance and financial infrastructure. a. Appropriate banking and prudent regulations and supervisory practices: This includes the effective capacity for prudent supervision and requires a specialized financial authority for its implementation. Prudent regulation should be established in accordance with known existing risks and should be sufficient (such as measures like registration, adequate accounts, prevention of fraud and financial crimes, or consumer protection). In some cases it might be necessary to introduce special regulatory categories for microfinance institutions because it is difficult (or impossible) to reform existing banking sector laws. Nevertheless there should be caution when regulating because specialized microfinance laws may end up marginalizing microfinance rather than integrating it within the financial system. b. Liberalized interest rates: Interest rate ceilings may make microfinance unattractive to NGOs and financial institutions and restrict institutions in providing credits to the poor. Interest rate ceilings can also lead to less certainty on the costs of loans and lenders will manage this problem by adding confusing fees to their services. There has been a call for deregulation of interest rates based also in the idea that the forces of competition will lower rates within a reasonable timeframe. However some countries still apply them and specific governmental measures on interest rates include (i) Setting interest rate ceiling or liberalizing interest rates. (ii) Requiring full transparency on rates and other costs for the borrower as well as full reporting on the efficiency of financial institutionsÂ´ operations. (iii) Supporting the careful design of subsidies to minimize distortions and to ensure transparency and the achievement of desired results, and (iv) Analyzing measures needed to lower market based interest rates, including issues of competition (market entry and regulations), access to funds, and the high cost of poor communication infrastructure and efficiency at institutional level.

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings c. Barriers to Entry: Intervening in the market by creating some barriers is an important policy tool if it assures the quality of the market participants. When it is badly designed it could prevent reduce competition and keep prices artificially high by allowing price collusion or preventing geographic expansion. d. Financial Infrastructure: It is the set of auxiliary services in the financial system of any country and can include an information and communication system for financial institutions, credits bureaus, property registries, bankruptcy processes and institutional credit ratings, among others. The policy measures are (a) To give priority to the elements essential in managing risk and reducing transaction costs (credit bureaus and information technology). (b) Support the establishment of guarantee funds. (c) To provide mechanisms for MFIÂ´s to link to infrastructure serving majors institutions. (d) To focus attention on the development of accounting principles, public disclosure of information, transparency and audit standards. (e) To set standards for service provision through the private sector or the public one (considering public goods such as training and capacity building). e. Consumer Protection: These policies seek to foster a more informed and fair relationship between costumers and financial institutions. The options are: (i) to increase consumer awareness (financial literacy initiatives), (ii) to increase information available to the consumer.(iii) to institute consumer protections, and (iv) to encourage the establishment of an independent oversight authority. f. Policy measures about the size and scope of financial institutions: Policymakers have to consider whether to decrease or increase the types of institutions that service their markets as well as decide what requirements institutions need to meet. The policy options are: (i) To ensure there are no barriers to entry or excessive expansion of lenders in the microfinance market. (ii) To design new legal forms to increase outreach and provide flexibility for those institutions to respond differently to different market segments. (iii) To consolidate the number or type of institutions because larger institutions can take better advantage of economies of scale and scope and by more easily supervised by the government. g. Finally, regarding the organization of the Government as a policy tool to promote financial inclusion, the institutional structure of financial services is extremely important in promoting financial inclusion. There are three political options: (i) to arrange various programs in multiple government departments, which is not advisable because of possible dispersion of supervisory functions and the lack of coordination and overlapping of functions. (ii) to bring together all inclusive financial initiatives under one ministry or authority, which frequently reduces administrative and operating costs and insures cohesion, however it can also isolate the financial inclusion action from the financial sector and diminish creative thinking and innovation. (iii) to develop a financial sector development strategy, assigning the responsibility to the Government department in charge of the financial system. Because there are a great number of examples of government protection we are going to analyze the protection framework implemented in each country and check whether they have followed our suggestions to implement appropriate regulation and good financial infrastructure. The evaluation will be based on the following: a. Analysis of the existing regulations and supervision of microfinance, b. Determination of whether there are barriers to entry. c. Determine if there are rules for consumer protection.

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings d. Determine if there are rules on interest rates and what organization in the government is in charge of microfinance. e. Determine the existence of a financial infrastructure like credit rating agencies, information system, guarantees funds, credits bureaus, and so on. II. EVALUATION OF THE GOVERNMENT ROLE IN MICROFINANCE IN SOME LATIN AMERICAN COUNTRIES The criteria we use for evaluating the role of government in microfinance will be determined by the existing guidelines in the relevant literature. We also summarized the features of the government’s role in microfinance using the three Ps as they were presented in one of CGAP´s articles. Then, each of these issues will be evaluated for five Latin American countries selected: Bolivia, Ecuador, Nicaragua, Peru and El Salvador. Studies on government roll and actions in microfinance have only been recently conducted and the theory emphasizes what governmental actions might achieve better results. Since the three roles analysed have evolved differently and have different effects on the market for financial services, the conclusions do not lead as to a set of guidelines for best practices in all cases. Therefore it is necessary to take a different approach in analyzing the roles of each in the countries selected. With regard to the promotion role we will analyze if governments have implemented any action inside this field at all and what kind of actions are most used and useful in these countries. With regard to the provision and protection roles there is much more evidence so we may also define guidelines for good practices and contrast them with the performance of the Governments under analysis. Ii.1. Role of The Government of Bolivia in Microfinance Provision There are two public institutions working in the field of microfinance in Bolivia and we will briefly describe their objectives and compare some of their financial performance with others in the private sector and check whether they comply with the features offered by other institutions. a. FONDESIF: Fondo de desarrollo del sistema financiero y de apoyo al sector productivo. FONDESIF is a public institution working as a credit fund supported by donations from international and multilateral organizations and the Bolivia Government. Its purpose is to increase the number of financial institutions and specialized credit unions that are patrimonial based and to increase the amount of financial resources available. Its objectives are: (i) to increase the size of the portfolio available for financial assistance (ii) to provide technical assistance to microfinance institutions whether or not they have a license, and (iii) to support the development of microfinance industry. The micro credit program developed by Fondesif includes the following activities:

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

Financial Support for portfolio growth: Money is lent to financial institutions for microfinance activities and this program is directed at credit unions trying to formalize themselves, closed credit unions and any kind of financial nongovernmental organizations. Technical assistance: Technical assistance is given to promote the development of new financial products, increase institutional strength and expand financial services coverage. It is directed at regulated and non regulated MFIs and provides non reimbursable resources. Support for the development of microfinance as a sector: Non reimbursable resources are provided through private entities for undertaking activities that study or research relevant topics in different areas of microfinance as well as promote training activities. Assigning resources to MFIs: Resources are assigned through lending or subordinated obligations to MFI, most of which are directed at rural areas or semi urban ones. The mechanism functions through public concurrence or direct invitations to the MFIs. This last way is applied only in specific circumstances and requires international agencies to fulfil public policy.

b. Banco de Desarrollo Productivo (BDP) This is a second tier bank constituted under the legal form of a mixed joint-stock company. It is regulated by the Financial System supervisor and gives financing through financial institutions authorized (ICI)5, providing financial sector strengthening with special programs developed for micro and small enterprises. These programs have special conditions like a specific interest rate for the program and its own definition of microenterprises and specific purposes. They also establish the applicable interest rate for the final client. FONDESIF does not make available financial information that allows us to compare its performance with the performance of other private institutions. However, BDP has some financial indicators that give us an idea of its economic performance in the Bolivian market. Institutions Return on assets Return on equity Total Assets USD 1.7% 10.1% 231,500,000 BDP 13.1% 13.9% 16,470,789 Diaconia 7.9% 21.8% 26,776,125 CRECER 7.8% 29.6% 794,451 Emprender Source: Financial reports from public institutions and Mix Market data. This table is based in data published by the BDP6 itself and by Mix Market for 2006. The private institutions have been selected because they are a higher percentage in these indicators. As we can see in this table, BDP has the lowest percentage returns compared with these private institutions, which might be due to less effective administrative and accounting procedures but also because of their mission as a public institution.

â&#x20AC;&#x153;Instituciones crediticias intermediariasâ&#x20AC;? authorized by the BDP board of directors. The BDP had published in its web page a report about its risk rating made by Fitch Rating, the information provided has been taken from this report. 6

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

On the other hand, the following table identifies whether these public financial institutions are carrying out measures to guarantee the best possible performance in their role as provider, i.e., are they undertaking the steps suggested by the literature to achieve its best possible performance.

Institutions FONDESIF

BDP

Subsidized interest rates Differentiated regulation

Yes

Autonomy

No. Council integrated by 5 governmental workers.

Directed to poor people

Yes, specifically directed to the development of rural and semi rural areas. No.

Yes. Specific regulation related with microfinance definitions, types of credits and conditions. No. For its structure and general rules, follows ASFI norms for second tier banks. Decisions about its programs will be taken by a Council integrated by government workers. No. Directed to micro and small enterprises.

Commitment for financially sustainable administration Technical Assistance

Yes, but only through lending for the development of new financial products. Source: Authorsâ&#x20AC;&#x2122; own elaboration

Yes, although all their funds come from international donors and national entities. No.

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings Promotion As it has been already explained, because of the peculiar features of these measures, this analysis focuses only on which microfinance promotion measures have been developed and implemented.

Preferential mesures

Priority industry requirements or incentives

Incentives, subsidies or requirements promoting competition Smart Subsidies Programs

Other requirements over interest rates or portfolio quotas Government payments Government through bank accounts Payments Matching deposits or similar initiatives Poor people access as an Regulation objective Requires to collect and report data about the use of financial services Considers microfinance as an specific financial business Source: Authors’ own elaboration.

Yes, through the programs implemented in FONDESIF and BDP directed to micro entrepreneurs, microfinance institutions and poor people (example: program “Crédito Productivo”). FONDESIF credits to non regulated microfinance entities to increase portfolio. By means of FONDESIF, the Government of Bolivia provides non reimbursable resources for new financial products and institutional strengthening. No

Yes (Bono Juancito Pinto) No No, just an objective of some financial institutions. No

Yes (with specific regulation for microfinance)

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings Protection This is the most developed and agreed upon issue in the literature. The following table has been built in order to check whether the countries fulfil the guidelines for best practices in this field, and reflected whether that the country has implemented the listed measures.

Regulation

Interest rate set by the market Government Institutions

Prudent Non prudent Removal of entry barriers Specific consumer protection for financial clients Yes

Yes Yes Yes No

There are many Government institutions related with microfinance. The main one is the Supervision Authority of the Financial System (ASFI). Some others: Central Bank of Bolivia, the Direction of Credit Unions (Ministry of Labour) and FONDESIF (Ministry of Economy). Rating Agencies With no obligations concerning Financial the financial system Infrastructure Credit Bureaus Yes Information System ASFI Central Information System Guarantee Funds No Source: Authors’ own elaboration. Ii.2. Role of The Government of Ecuador in Microfinance Provision Government intervention in the microfinance sector in Ecuador is very intense. They have several programs which are performed by three different public institutions, mainly under the mechanism of second tier finance. a. El Programa Nacional de Finanzas Populares, Emprendimiento y Economía Solidaria (PNEES) was created in May 2007, is a public institution with complete autonomy and national coverage in scope. Their objective is to satisfy the financial services demand of the excluded sectors and poor people and try to improve their quality of life. They are also charged with strengthening microfinance institutions that work in this program and creating alternative financial markets which work for the local development. It has basically three components:

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

1. - Microcredit National Fund or Credit Fund, is a second tier mechanism that works through institutions whether or not they are regulated by the Financial Authority. These institutions must be previously selected under a mechanism of public auctions. 2. - Strengthening Regulation and Training Fund, is a set of resources destined to strengthen and train to microfinance institutions and microenterprises. 3. - Credit Guarantee Fund, is a fund that supports financial services and credit expansion. The Government through this program tries to promote entrepreneurial activities and capacities. They provide technical and financial support to financial institutions and promote cooperation between them for the development of new and better financial services. They have created 5 types of credits for individuals each with a different purpose and directed towards different groups of people: (i) Credit for Human Development, (ii) Social and Solidary Economy Credit, (iii) Juvenil Microfinance Credit; (iv) “Socio Panadero” and (v) “Socio Siembra”. Each is also designed for different subjects: microenterprises, artisans, fishermen, farmers, bakers, young people who want to start a micro business. b. Corporación Financiera Nacional (CFN), is a public development bank whose mission is to bring financial products and non financial products within the producing sectors of Ecuador. They grant credits to the small businesses and microenterprises and provide them training, technical assistance and cooperation from others institutions to strengthen their administration. They have many credit programs of first and second tier but we will only describe the programs related with microfinance. They also have the “Enterprise Partner” program which works through the second tier mechanism. This program allows access to micro credits and technical assistance to individuals or enterprises with “differentiated projects” or projects that are characterized by technology innovation. The micro credits in this program cannot be greater than 20,000 USD for individual projects or 100,000 USD for group projects. There is also a program called “Credimicro” whose purpose is to finance the acquisition of fixed assets, working capital or technical assistance. It is directed at activities on small scale and also has specific requirements on quantity, terms, guaranty and the like. c. Banco Nacional de Fomento (BNF), is a public institution whose mission is to help in the development of the country and support sectors which use credit for economic and social development. They have implemented many different credit programs to fulfil their mission, including one called “Credit for the Human Development” with an interest rate of 5% per year and other conditions specifying term, quantity, and subjects. A second one called “Microcredit” is directed at all people dedicated to productive activities, with interest rate of 11% per year for the productive sector and 15% per year for the trading and services sectors (it also establishes specific conditions as a to the maximum term, quantity, guaranties and subjects). Finally a third one is called “555 Credit”, directed to all production and must be used for the acquisition of fixed assets or working capital.

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings Those three institutions are examples of government involvement directly in microfinance but there are others. Because there are so many, the government created “Info Inclusión” which is a tool to find information about projects and programs directed at the social and productive sector. These are programs which can be implemented by any government department to be mainly directed at agricultural, productive, and handcraft areas as well as microfinance. This tool provides information for people who want to look for support in any of the mentioned areas. We have collected available financial information from these public institutions to compare their performance with that of other private institutions7. The information from the public institutions described is not available in all cases but we did have access to the complete report of the Risk Qualification made for the BNF which help us to create the following table: Institutions Return on assets Return on equity Total Assets USD 0.7 % 2.3 % 758,000,000 Banco Nacional de Fomento 9.95% 10.8% 1,640,849 UCADE Ambato 8.7% 24.4% 2,057,267 Fundación Alternativa 8.5% 16.4% 1,786,184 UCADE Latacunga Source: Financial reports from public institutions and Mix Market Data. The results show poor performance by BNF compared with private institutions. This could possibly result from the fact that the public institutions’ main goal is related to social development and not economic efficiency. In the case of the CFN, we could only find the final results of their Risk Qualification, information available on the web page of the financial authority.8 These results compared with BNF lead us to think that they are higher than the ones presented in the table above because BNF’s final Risk Qualification was BBB- in 2007 while CFN’s was A- for the same year. We could not find any information of this type available from the PNEES.

For the Private Institutions information we have used the Mix market Data. We have chosen institutions with the best performance in 2007 for ROA, ROE and Total Assets indicators. 8 We can check this information online: http://www.superban.gov.ec/practg/sbportal.p_index?vp_art_id=166&vp_tip=2#2

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings We have built the next table identifying whether they fulfil the criteria given for the “best performance” in the provider role.

Institutions CFN (Programa BNF Credimicro) Yes. It depends of Subsidized interest No. However in all No. cases it should be the program, and rates considered the should also maximum rate of consider the active interest. maximum rate established. Yes, in all cases Yes. Yes. Differentiated specific legislation regulation has been designed for the institution. No, all of them No. No. Autonomy have as members of their Board of Governors, public workers. No No Directed to poor Yes people It is not clear No. He has his own Commitment for No from its regulation as a financially sustainable regulation. bank. administration However they are also submitted to the control of the financial authority which guarantees certain kind of financial sustainable administration. Yes Yes, in both cases No Technical Assistance this support comes together with their financial services. Source: Authors’ own elaboration. PNEES

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings Promotion and Protection: We have summarized the performance in Ecuador in two tables as was done in the case of Bolivia. Promotion Preferential treatment measures

Priority sector requirements Yes, through the programs or incentives implemented by the three institutions analyzed, they are required to grant credit to individuals with small projects, poor people or microenterprises. Incentive, subsidy or No requirement promoting competition Smart Subsidies programs No, however there is a similarity between this issue and the program “Enterprise Partner” Other requirements over No interest rates or portfolio quotas Government payments No Government through banks accounts payments Matching deposits or similar Yes. It is called Credit of Human Development, granted by NPPSE only to the beneficiaries of the human development bond. Consider the objective of Yes, but in a specific Regulation poor people access regulation, not in the regulation of the financial system Require to collect and report No data about the use of financial services Consider microfinance as a No, they regulate business line microfinance as a non differentiated part of the financial system. Source: Authors’ own elaboration.

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

Protection Role Regulations

Prudential Yes Non Yes prudential Do not have Yes entry barriers Specific Yes. Each financial institution has responsible consumer body of the consumer protection, called “Defensor protection for del Cliente”. financial clients No completely. There is a maximum active interest rate in each Liberalization credit segment (which includes micro credit), that will correspond of interest rate to the average rate considered by the amount of the credit operations granted in every segment, multiplied by a factor to be determined by the Board of governors of the Central Bank of the Ecuador. Microfinance activities and regulation is dispersed over many Governmental institutions and microfinance treatment is different from the public Organization sector perspective than from the private one. There is one public institution who tries to concentrate all the information about microfinance programs (Infoinclusion). The institutions in charge of microfinance from the perspective of the financial system are the Superintendence of Banks and the Superintendence of Supportive Economy (for credit unions) Rating Agencies Each financial institution must Financial hire the services of a rating Infrastructure agency, qualified to perform this job by the financial authority Credits Bureau There is a Risk Central Agency administered by the Government and Credits Bureaus run by private people. Information System Yes. The financial authority has its own institutions to join the debtors’ information from all financial institutions. Guarantee Funds Yes Source: Authors’ own elaboration.

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings Ii.3. Role of the Government of Nicaragua in Microfinance The role of government in microfinance in this country is much smaller compared to both countries already reviewed. We have found only two programs that focus mostly on development in rural areas. There are very few incentives to work in microfinance and there are no requirements or subsidies available and regulation is not very specific. However, microfinance is defined in the country’s financial regulation with the purpose of achieving a better balance in a financial institution’s portfolios. With regard to the direct provision of microfinance we have found two important institutions working in this field: a. Financiera Nicaragüense de Inversiones (FNI): It is a company whose main stockholder is the Nicaragua Government. FNI’s mission is to finance productive initiatives by individual entrepreneurs or enterprises. They provide the following services: (i) credits to financial institutions and development agencies supervised, (ii) custody and administration of funds and (iii) promotion, coordination and guiding of public and private funds to the capitalization of enterprises (their mission there is to contribute to the economic development of Nicaragua). (iv) credits to individuals and their associated companies, and (v) credits to micro, small and medium entrepreneurs from both rural and urban areas. They operate as a second tier bank and have many areas of financing. Among them are two program specializing in microfinance “Microfinance MKF” and Development Fund of the Rural Worker. The first program works with funds of the Dutch Cooperation Agency. Its objectives are: to improve sustainable access to efficient financial services for small and microenterprises; to contribute to the improvement of worker’s earnings and workplaces and to strengthen regulated MFIs as efficient institutions for micro and small enterprises. The maximum amount of credit is 15,000 USD and with a maximum interest rate of 15% per year. The second program works with funds from the Nicaragua government and the International Fund for Agriculture Development. This fund finances rural production from a northern region (trópico seco) which is located in the departments of Madriz, Nueva Segovia and Estelí. The clients are rural entrepreneurs working in agriculture or microenterprises as artisans and so on. b. Fondo de Crédito Rural: It is a public institution which provides financial services in rural area. Their vision is to be leaders in the providing rural financial services in a sustainable way and to contribute to reducing poverty in rural areas. They finance sustainable productive activities through credit unions, associations, regional governments, foundations and so on. Their objective is to guarantee the access to credit for small, medium and micro producers. They have credits outstanding directed at the transforming the agricultural industry, microenterprises activities and tourism. They basically work through four programs with small producers and the description of their programs does not make any specific reference to micro producers; however the credit amounts are very small and are directed at financing the productive activities for small initiatives. One of their programs is directed at coffee producers and another is directed to diversify production in rural areas, as well as for processing and export of agricultural and agro industrial products and services from rural areas. Pasos (2009) in “Microfinance in Nicaragua” briefly describes the Government programs and the funding related with microfinance. She asserts that there are many governmental institutions

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings working to direct microfinance to productive activities in rural areas. These funds are given to financial institutions, credit unions and NGOs. The National Institute of Development, the Agricultural Department, the Small and Medium Enterprise Institute, among others, provide credit funds. We have checked the web pages of these institutions and confirmed that all their funds are given the Rural Credit Fund in programs already explained. In order to compare the performance of the governmental actions with the private performance in microfinance we have looked at several financial indicators. For private institutions we have chosen the three best institutions “return on assets” from data available in Mix Market9. For public institutions we only found some financial data from Financiera Nicaragüense de Inversiones10 for 2008. Institutions Return on assets Return on equity Total Assets USD 9.99 % 5.4 % 2,376 FNI 10.1% 24.6% 22,485,968 Prodesa 6.4% 33.7% 8,766,661 Afodenic 6.2% 9.5% 5,951,012 Pro Mujer – NIC Source: Financial reports from public institutions and Mix Market data. The Rural Credit Fund only gives access to their Balance Sheet and Earning Report so it is not possible to compare lending within it. FNI’s performance is relatively good even though they have the lowest “return on equity”. This is probably due to the fact that it is supervised by the financial authority and subject to the financial system rules. With regard to the role of FNI and Rural Credit Fund as direct providers of microfinance, and considering the criteria explained about the best performance possibilities of this role, we have built the following chart as in the previous cases.

Available online at: http://www.mixmarket.org/mfi/country/Nicaragua/calculation_usd.return_on_assets%2Ccalculation_usd.return_on_e quity%2Cbalance_sheet_usd.total_assets/2008?order=calculation_usd_return_on_assets&sort=desc 10 Available online at: http://www.fni.com.ni/index.php?option=com_content&view=article&id=191&Itemid=145

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings Provision Institutions FNI Rural Credit Fund Yes. Interest rate depends on Subsidized interest No. the specific program. rates According to the Law NÂş 294, financial intermediaries will not increase the interest rate for the final user in more than 2% over the interest rate paid to the Fund. In any case they are below the market interest rate. Yes. In many issues it is Yes. Differentiated regulated by the financial Regulation authority; however it has specific prudential regulation. No No Autonomy Yes Directed to poor Yes people its regulation It is considered as part his Commitment for Yes, that the vision however does not financially sustainable establishes requirements applied for have any specific procedure administration formal financial institutions to show the fulfilment of this also apply to the FNI. objective. No Yes, inside each specific Technical Support program, provided by the Nicaragua Institute of Agricultural Technology or by financial intermediaries. Source: Authorsâ&#x20AC;&#x2122; own elaboration. Having analysed the governmental programs and regulations on microfinance with regard to the protection and promotion roles we have build the same tables as in the cases of Bolivia and Ecuador to analyse how they perform.

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

Promotion Preferential treatment measures

Priority sector requirements The programs established by or incentives the FNI and the Credit Rural Fund perform as incentives to work with microenterprises or rural population. Incentive, subsidy or No requirement promoting competition Smart Subsidies programs No Other requirements over No interest rates or portfolio quotas Government payments No Government through banks accounts payments Matching deposits or similar No Consider the objective of No Regulation poor people access Require to collect and report No data about the use of financial services Consider microfinance as a No, but they consider micro business line credit as a credit portfolio. Source: Authorsâ&#x20AC;&#x2122; own elaboration.

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

Protection Regulations

Prudential Yes Non Yes prudential Do not have Yes barriers to entry Specific No consumer protection for financial clients No completely (art. 39 BCR Law). They moratorium interest Liberalization of Interest Rate ceiling that establish it cannot be more than 50% over the current interest rate. The issues related with microfinance are worked by different Governmental institutions. There is not coordination between the development of Organization microfinance through the financial system and the others governmental bodies. Rating Agencies No Financial Infrastructure Credits Bureaus Yes Guarantee Funds No Information System Not exactly. They have the obligation to inform to the general public about people who are behind in their loan payments. Source: Authors’ own elaboration. Ii.4. Role of The Government of Peru In Microfinance Regarding the direct provision of micro credits and the existing governmental programs related to microfinance we have found four kinds of institutions performing the role of direct provider in Peru. We are going to briefly analyse each of these institutions and their programs and evaluate how their activities relate to the theory explained. a. Banco de la Nación (BN): It is a public enterprise and part of the Economic and Finance Department. It has economic and finance autonomy with its own norms and promotes financial inclusion and financial services´ decentralization. It has many programs directed at public and private clients but there are two that are related to microfinance: (i) Crédito Mype and (ii) Promype or Programa de apoyo financiero a la micro y pequeña empresa.

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings (i) Crédito Mype is directed at all micro and small enterprises. Although BN is responsible for the success of this program it only works as a support institution. Credits are given to final users by specialized institutions such as Edpymes, CMACs and Cajas Rurales. The credit conditions (interest rate, term, guarantees) are established by the financial institutions themselves. These entities sign operating agreements with the BN; one agreement is for financial cooperation, the other is to share infrastructure and the final one to open a credit line. The main benefit for the financial institution is that they can now reach new markets without taking additional fixed costs. BN also provides a credit line to supply resources to supervised financial intermediaries which are dedicated to microfinance. This credit line has been established with the purpose of increasing financial services for micro and small enterprises. They specify that a minimum of 40% of the credit portfolio must be directed to micro and small enterprises in order to participate in the program. They do not fix the interest rate but specify that it should not be included in overhead which is reported to the financial authority supervising the institution. (ii) Promype provides a financial support program for the micro and small enterprise as well. This program grant funds to financial intermediaries who are directing credits to micro and small enterprises. Financial intermediaries have to compete for the funds under the inverse auction modality and an important factor in determining the winner is whether the financial intermediary is charging a lower interest rate to micro and small enterprises. These credits also cannot be for a term longer than 180 or 360 days and the entities become clients of BN. b. Corporación Financiera de Desarrollo (COFIDE) is a company which is 98.7% owned by the government and 1.3% owned by private stakeholders. In spite of this they have economic and administrative autonomy and are part of the financial system as a second tier bank. They are able to perform all kind of finance intermediation activities established in the laws. Their activities are focused on facilitating the financing in the medium and long term to micro and small enterprises and to the export sector. They collect resources from international organizations, commercial banks and the capital markets and then channel those resources to the entrepreneurial sector through supervised financial institutions. They report that many of activities support micro and small enterprise (orientation services, information, technical and administrative support, etc) and they have five different credit programs: (i) Microglobal, (ii) Propem, (iii) Productive Habitat, (iv) Subordinated Credit and (v) Fondemi, (i) Microglobal´s aim is to increase access for micro and small enterprises (urban or rural) for their productive activities in trade or services. Credits in this program allow people to finance fixed assets and working capital. Recipients are people working in production or rural activities, such as trade or services. To be considered the enterprise cannot have more than 10 workers and their assets should not be above 20,000 USD excluding immovable property. The interest rate for the final users and guarantees are established by the financial institution by itself. (ii) Propem´s objective is to promote national private small enterprises by financing the establishment, expansion and improvement of their infrastructure and assets, as well as their working capital, design cost and support services. To be considered for this program the enterprises are ones whose sales are equal or less to 1,500,000 USD. In this program Cofide open credit lines for financial intermediaries or conducts rediscount operations with them in order to

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings finance small and microenterprises. Each financial intermediary establishes the interest rate for the final user; however there is a maximum amount of credit and a maximum lending term of no greater than 10 years. (iii) Productive Habitat is a program whose goal is to contribute with the improvement in earnings and employment consolidation in the Peruvian microenterprise industry. This program gives priority to population affected by “El Niño” phenomenon and where the Housing Department works to develop urban areas or where its activities are done with Spanish cooperation. The beneficiaries of this program are people who are working in factories, trade or services´ activities who do not have more than 10 workers or total assets above $20,000 USD (excluding immovable assets). The credits should be directed at the acquisition of machinery and equipment, working capital, or the acquisition, construction or expansion of their business. The financial intermediaries have to sign contracts with COFIDE in order to receive the resources. The interest rate for the final user is established by the financial intermediary and they cannot provide credits for activities with negative environmental impacts. They also have specifics limitations on the terms of credit and maximum amounts. (iv) Subordinated Credits provides financing to small and microenterprises by strengthening equity of specialized financial intermediaries. This program will provide subordinated credits to supervised financial intermediaries who are eligible for this program. The maximum amount of credit available for a financial intermediary is 2,000,000 USD and the maximum term to repay them is 10 years. This kind of program also imposes some restrictions on the financial intermediary; they must capitalize at least 50% of their profits (after taxes), they must maintain the financial conditions that made them eligible for this program and they must have separated financial records for the subordinated credits. (v) The goal of Fondemi is also to channel resources to finance small and microenterprises. This program is part of the Entrepreneur Peru Program from the Working and Employment Department directed to grant financial services. The beneficiaries must be working in producing, trading or services activities and must also meet the following criteria: have no more than 10 workers, have total assets at or below 20,000 USD (excluding immovable assets) and owe no more than 10,000 USD. Cofide will open a credit line to work with the financial intermediaries and the loans to the final users should be directed at acquiring fixed assets or working capital. Financial intermediaries have 3 years maximum to repay the credit to COFIDE and the interest rate is established by the financial institution. Besides these five programs COFIDE has one program called Sepymex which was also created to promote and support small and medium export enterprises by providing them insurance coverage on their pre landing credits from financial institutions. The goal is to support the improvement of small and medium export enterprises. They define small and medium enterprises as those whose exports are not be over 8,000,000 USD or the ones who wants to start exporting goods. c. Agrobanco is a financial enterprise created by law to provide credits to agricultural, cattle farming and aquaculture activities and to transform trade from this sector. Its objective is to increase production, capitalization and the development of the quality of life of livestock

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings producers in a sustainable way. They direct financial products to micro, small and medium size producers and promote their economic development. They work with direct and indirect credits; the first ones are directed to small producers organized in productive chains, productive associations or groups linked in the production process. Under a scheme of constant supervision and technical assistance the objective of these loans are to help firms achieve economies of scale, reduce costs, optimizes earnings and become better borrowers. For medium size producers there are also many other types of direct credits. The second ones are given through credit lines and special financing programs developed with financial intermediaries (banks, municipal and rural savings and loans funds). These credits help increase the supply of credit to medium size livestock producers who are organized in productive chains. According to the law they can provide a preferential interest rate on direct credits. They also have a financial product called “Solidarity / Supportive Credit” which is directed at micro and small producers from Agricultural Communities. This product grants credits to groups in communities that are organized and are able to repay the credit. This product requires the commitment of the community to debt repayment and finances 60% of the total cost of the project. The special features of this credit are the preferential interest rate, the technical assistance provided and the possibility of accessing another credit line when the project is finished and the result is successful. d. – Cajas Municipales de Horror y Crédito (CMACs): These institutions are nongovernmental organizations whose owner is the local government of some specific territory. Among other things they also offer credits to micro and small producers. They have administrative and economic autonomy and are under the regulation and supervision of the financial authority. As there are many of these institutions and each one perform its activities in an independent way, each has different programs with different conditions for obtaining micro credits. They also count as a fund whose aim is to channel financial resources from national and international entities to the municipal saving banks and is also supervised by the financial authority Finally in order to evaluate their financial performance in the same way as we did with other countries we compare some of their financial indicators with financial indicators of some private institutions. The data was obtained from the Mix Market web page for 2007 year and the private institutions chosen were those that had the best ROA (return on assets).

Institutions BN* Cofide* Agrobanco* Pro Mujer – Per Fovida Edpyme Efectiva

Return on assets 1.7% 1.1% 1.0% 13.9%

Return on equity 20.6% 2.7% 1.2% 26.0%

13.3% 12.7%

15.4% 69.95%

Total Assets USD 6,437,300 1,326,000 103,200,000 9,364,489 1,160,142 21,924,469

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings Source: Financial reports of public institutions from IEP (Peruvian Studies Institute) and Mix Market data. As we can see the financial performance of public institutions is very poor compared with the financial results in the private institutions. We decided not to include the data of the CMACs as they are too many and their administration is completely different from the other public institutions. In order to analyze how they perform in their role as direct providers we have built the same table as in the other counties to check whether they were following the best practices. .

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings Provision:

BN interest No

Subsidized rates

Differentiated Regulation

Autonomy

Directed people

Yes, the financial system norms only apply when there is not applicable law. No

poor No

Cofide No

Institutions Agrobanco CMACs Yes. Fixed by No Agrobanco and below market. the Yes No

Yes, financial system norms only apply when there is not applicable law.

No, even No when its law establishes the normal procedure (for a private company) of election of the board of directors. No No, although between its duties it is established that the directory should set aside 25% of their funds to grant credits to people in rural extreme poverty zones. Yes No

Limited, they have as members of the board of directors, two or three municipal workers among others. No

Yes Commitment for No financially sustainable administration Yes Yes Yes Technical Assistance No Source: Authorsâ&#x20AC;&#x2122; own elaboration. 52 Microfinance and the Role of Government in Latin America Copyright ÂŠ 2010 Pfeiffer University All rights reserved. For permission contact microfinance @pfeiffer.edu

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

Provision and Protection Regarding the performance of the provision and protection role we summarize our findings in the following tables: Provision: Preferential treatment measures

Priority sector requirements Yes, incentives to work with or incentives micro and small enterprise sector are given through programs like Mype Credit, Promype, Fondemi, Microglobal and so on. Incentive, subsidy or No. requirement promoting competition Smart Subsidies programs No Other requirements over No interest rates or portfolio quotas Government payments Yes: The program “Juntos” Government´s through banks accounts. through the BN. payments Matching deposits or similar No Consider the objective of No. However in the Small Regulation poor people access and Microenterprise Law they state that credits for this collective are a matter of public interest. Require to collect and report No data about the use of financial services Consider microfinance as a Yes. They regulate business line microfinance as a specific credit portfolio and also have specific institutions working for this kind of collective. Source: Authors’ own elaboration.

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings Protection. Regulations

Liberalization of Interest Rates Governmental Organization

Prudential Yes Non Yes prudential Do not have No barriers to entry Specific Yes, specifically for the financial system consumer consumer. protection for financial clients Yes. There are no limits for operations inside the financial system.

There are different institutions working in microfinance from the public perspective and only one of them provides direct credits to the microfinance sector. The financial authority is in charge of the supervision of most of direct providers. There seem to be no coordination between the different governmental programs and the financial authority action in microfinance. Rating Agencies Also regulated by the Stock Financial market authority Infrastructure Credits Bureau Yes (One Public and many privates) Information System Yes, the financial authority Guarantee Funds Yes. Constituted as private entities with no profit motive in mind. Source: Authors’ own elaboration. Ii.5. Role of The Government of El Salvador In Microfinance With respect to the provision role in microfinance, El Salvador´s government had created two big institutions to work in the microfinance that can bring credits directly to the public or as a second tier mechanism. a. Banco Multisectorial de Inversiones: It is a development bank which provides access to finance for businessmen, students, professionals and nationals abroad with the goal of providing inclusive development implemented through innovative financial products, second tier credits and guarantees, and provision of complementary services and knowledge, among others. There is a program called “Tu Crédito” whose aim is to promote the development of microenterprises in El Salvador by focusing on poorest places. They provide credit through

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings financial intermediaries which are especially directed to rural trade, industry or services activities. They also have a program called “Fondo de Reconversión Productiva” (FRP) which was created to promote the use of renewable energies and is directed at micro, small and medium enterprises. Credit is not only provided through this program for the project but there is also non reimbursable technical assistance and complementary guarantees of access to credits. It is directed at reducing primary inputs of water, energy and so on, and changing or substituting machines and equipment which reduce emissions, use renewable energies and does everything that contributes to reduce environmental pollution. They only finance the 80% of the investment. Another program in the microenterprise sector is Proyecto Milenia; this program provides technical assistance, guarantees and credit lines to various clients including microenterprises. Some of their programs are directed to specifics sectors, as in the north of El Salvador or the rural sector and there is another program called Fidepyme created to provide financial resources at market prices to entities who also specialize in providing financial services the micro sector. These programs provide two credit lines; one for entrepreneurs with specific requirements and another for micro and small enterprises. Both of them must be used as working or investment capital and for the acquisition of goods or for the transformation of their establishments. b. Banco de Fomento Agropecuario (BFA): BFA is a public bank which is self sustainable and promotes the development and strengthening of the livestock and agro industrial sector. They try to meet the financial needs of micro, small and medium enterprises in a competitive way and their final goal is to contribute to the economic and social development of the country. They have specific credits directed to microenterprises to finance all kind of productive activities and their objective is to boost viable productive activities in trading and the industrial and service sectors. We have compared the ROA from both public institutions with the information of the best private institutions from El Salvador. As the following chart indicates the public institutions´ financial performance is very low compared to private institutions. Institutions Return on assets Return on equity Total Assets USD 0.8% 2.6% 609,000,000 BMI 0.4% 3.0% 213,000,000 BFA 8.57% 9.86% 1,410,374 ASEI 4.67% 10.38% 8,122,575 ENLACE 4.42% 10.42% 7,713,179 FUNDACIÓN CAMPO Source: Financial reports of public institutions from IEP (Peruvian Studies Institute) and Mix Market data.

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings Provision and Protection The evaluation of the government´s provider role follows the same criterion in previous cases, to verify whether public financial institutions are following the best performance guidelines. Provision Institutions BMI No Subsidized interest rates No. Although it is guided Differentiated also by some special rules. Regulation No Autonomy No. Directed to poor people Yes, it is also specified Commitment for between its corporate financially values. sustainable administration Technical Assistance Yes Source: Own elaboration.

BFA No No. However it is also guided by specific regulation. No No Yes, it is specified mission.

in its

For the performance of the government´s promotion role in microfinance, as we have already explain, we can only check the kind of actions implemented with this purpose, although we have used the same chart as in previous cases.

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Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

Promotion Preferential treatment measures

Priority sector requirements or incentives

Incentive, subsidy or requirement promoting competition Smart Subsidies Programs Other requirements over interest rates or portfolio quotas Government payments Government through banks accounts payments Matching deposits or similar Consider the objective of Regulation poor people access Require to collect and report data about the use of financial services Consider microfinance as a business line (to have specific institutions working in this field) Source: Authorsâ&#x20AC;&#x2122; own elaboration.

Yes. Including programs directed to microenterprises or entrepreneurs in the poorest regions. No.

Yes. No.

No.

No No

Yes

For the evaluation of the Protection Role we have follow the same criterion as in previous cases:

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Liberalization of interest rate Governmental Organization

Prudential Non prudential Do not have barriers to entry Specific consumer protection for financial clients Yes

Yes. Yes Yes.

No.

There are some institutions working in this field, and as in other cases there seems to be no coordination among them. However their activities do not seem to overlap and both public institutions are under the supervision of the financial authority. Rating Agencies Yes. Financial Infrastructure Credits Bureaus Yes. There is a Central Risk System. Information System Yes. Guarantee Funds Yes. Source: Authorsâ&#x20AC;&#x2122; own elaboration.

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings CONCLUSIONS A new approach for the financial system has been provided by microfinance since the 1970s, when financial institutions began to understand that poor people could also participate in the financial system in a sustainable way. Today governments are trying to fight poverty with the help of microfinance and this has become an important reason for the establishment of rules and measures which promote microfinance industries. With increasing government action in microfinance, as well as new interest in supporting government initiatives for financial inclusion of poor people, there has been a growing interest in defining the best governmental practices in microfinance. Following CGAP, we have summarized these government actions into three main overlapping activities: Provision, Promotion and Protection. The Provision role is seen as a de facto activity and is the most criticized one because of the negative effects it is assumed to have on market competition. However, most authors suggest that there are some criteria that can be taken into account in order to guarantee a good performance by government in this role. The provision role is then classified into two activities: the direct provision, with public institutions bringing credits directly to micro clients, and the indirect provision, with public institutions working as second tier banks or opening credit lines for microfinance institutions. The Promotion role is described as a group of government initiatives to achieve financial inclusion or to fight market failures. Some typical activities in this role include promoting transparency, as well as a performance based agreements between the Government and financial institutions to incentivize and promote microfinance. However, the effectiveness of the promotion role is not clear and needs to be judged on a case by case basis. The typical promotion actions include subsidies and other types of incentives and requirements to improve microfinance institutions performance or their clientsâ&#x20AC;&#x2122; situation, as well as technical assistance for these same purposes. There are doubts about the provision role because of its impact on competition and the sustainability and development of the industry. The Protection role is the one which generates lowest level of debate because there is almost unanimous agreement that the Government should provide certainty and protection to the users of financial services. That requires the appropriate financial regulation of microfinance in addition to establishing conditions for building suitable financial infrastructure. We provided an analysis of the government role in microfinance in five chosen markets in Latin America (those with the highest percentage of their population served by microfinance institutions) to allow us to determine how each of these roles in microfinance has been fulfilled in these countries, specifically with respect to the provision and protection role. Regarding the provision role in microfinance we conclude that in most cases it does not follow the standards suggested by the literature. We have noticed that governments are actively involved in microfinance whether through direct or indirect provision. Each of the analysed countries has at least two institutions providing credits to microfinance institutions or final users. However,

Microfinance and the Role of Government in Latin America

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings these activities are not carried out according to the best practices suggested. Most of the institutions analyzed show a lack of autonomy, follow specific rules or laws, and do not have a commitment to become a sustainable financial institution. The remarkable exception is the case of the CMACs in Perú. Technical assistance, on the other hand, is the only issue that most of the public financial institutions do provide their clients. Concerning the promotion role in microfinance, and given the fact that it is not possible yet to establish a set of best practices, we have only evaluated how the aforementioned countries have implemented this kind of actions. Actual promotion actions are very few. All of the surveyed countries have developed priority sector incentives. Nicaragua is the one that presents the lowest level of governmental action in the promotion of microfinance. Perú, Ecuador, Bolivia and El Salvador have developed some other kind of actions related to governmental payments, including access by the poor and establishing microfinance as a line of business. The protection role by government role in microfinance is achieved in all five countries which have established suitable regulation and an appropriate financial infrastructure. Almost all maintain information systems, credit information departments (credits bureaus), and rating agencies, for instance. However, we must point out that there is still room for improvement in this area. Apart from the appropriate prudent vs. non prudent regulation and the removal of entry barriers, the liberalization of interest rates and the development of stable financial infrastructures are important factors contributing to the growth of microfinance in these markets. This analysis leads us to conclude that being in countries with the highest percentages of population served with microcredit services does not necessarily mean that they are following the best practices as it related to the government’s role in microfinance. The provision and protection roles are the most developed ones but the achievement of the protection role is probably the main reason for the success of these countries as measured by the population covered by microfinance services. We can only conclude that if the provision role had been performed the way the literature suggests that the share of the population by microfinance enterprises would likely be higher. REFERENCES Agrobanco de Perú. http://www.agrobanco.com.pe/presentacion.htm Autoridad de Supervisión del Sistema Financiero de Bolivia, http://www.asfi.gov.bo/ Banco de Desarrollo Productivo de Bolivia. http://www.bdp.com.bo/ Banco Nacional de Desarrollo de Ecuador. http://www.websysecuador.com/bnf_2/ Banco de Fomento Agropecuario de El Salvador. http://www.bfa.gob.sv/ Banco Multisectorial de Inversiones de El Salvador. https://www.bmi.gob.sv/portal/page?_pageid=38,91121&_dad=portal&_schema=PORTAL

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Bank de la Nación de Perú. http://www.bn.com.pe/default.asp Bancos Públicos y Finanzas Rurales. http://www.bancosdesarrollo.org/ CGAP (2004). “Key Principles of Microfinance”. CGAP – G8 Summit, 2004. USA. Available online at: http://cgap.org/gm/document-1.9.2747/KeyPrincMicrofinance_CG_eng.pdf CGAP (2009). “Government’s role in microfinance: What is the optimal policy mix?” CGAP, January, 2009. Available online at http://www.cgap.org/p/site/c/template.rc/1.26.4903/ Corporación Financiera de Desarrollo del Perú. http://www.cofide.com.pe/index.html Corporación Nacional Financiera de Ecuador. http://www.cfn.fin.ec/ De Janvry, A. Sadoulet, E., McIntosh C., Wydick, B., Luoto, J., Gordillo, G., Schuetz, G.,Valdivia, M., Bauchet, J., Herrera, C., Kormos, R., (2003). “Credits Bureaus and the rural microfinance sector: Peru, Guatemala and Bolivia”. A joint project between The University of California at Berkeley and the FAO Office for Latin America. Duflos, E. and Imboden, K., (2004). “The role of Governments in Microfinance”. Donor Brief Nº 19, June, 2004. CGAP. Duflos E. and Glisovic-Mézières J. (2008). “National Microfinance Strategies”. CGAP Brief. CGAP. Available online at: http://cgap.org/gm/document-1.9.4349/Briefs_NatMicroStratUpdate.pdf Economist Intelligence Unit, (2009). “Microscope in the Microfinance Business Environment”. CAF – BID – IFC. Available online at http://idbdocs.iadb.org/wsdocs/getdocument.aspx?docnum=2189220 Fernando, N. (2003). “Do governments in Asia have a role in development of sustainable services? Some views”. Asia Development Bank. Federación de Cajas Municipales de Ahorro y Crédito. http://www.fpcmac.org.pe/ Financiera Nicaraguense de Inversiones. http://www.fni.com.ni/ Fondo de Crédito Rural de Nicaragua. http://www.fcr.gob.ni/index.php?option=com_content&view=category&id=4&Itemid=19 Fondo de Desarrollo del Sistema Financiero y de Apoyo al sector Productivo de Bolivia. http://www.fondesif.gov.bo/ Gehrke M., Martínez R. and Rondón M., (2008). “Liga de Campeones 2008”. Microempresas América, Otoño – 2008. Microfinance Information Exchange.

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Helms, B. (2006). “Access for All”. Building Inclusive Financial Systems. CGAP. Littlefield, E., Helms, B. and Porteous, D. (2006). “Financial Inclusion 2015: Four scenarios for the future of microfinance”. Focus Note Nº 39, CGAP. Nimal, F. (2003). “Do governments in Asia have a role in development of sustainable microfinance services? Some views.” Asian Development Bank. Available online at: http://www.adb.org/Documents/Slideshows/Microfinance/Fernando_paper.pdf Pasos, R. (2009). “Microfinanzas en Nicaragua”. Serie Financiamiento del Desarrollo 218. CEPAL. Peck R., Liman T. and Rosenberg R. (2006). “Microfinance Consensus Guidelines”. CGAP Programa Nacional de Finanzas Populares de Ecuador. http://www.finanzaspopulares.gov.ec/ Superintendencia de Banca, Seguros y AFP del Perú. http://www.sbs.gob.pe/0/home.aspx Superintendencia de Bancos y Seguros del Ecuador. http://www.superban.gov.ec/practg/p_index Superintendencia de Bancos y de otras instituciones financieras de Nicaragua. http://www.superintendencia.gob.ni/ Superintendencia del Sistema Financiero de El Salvador. http://www.ssf.gob.sv/ United Nations Department of Economic and Social Affairs and The United Nations Capital Development Fund (2006). “Building Inclusive financial sectors”. United Nations. Available online at: http://www.uncdf.org/english/microfinance/pubs/bluebook/pub/index.php?get_page=contents

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HOW MICROFINANCE TRANSFORMS THE MATERIALLY NON-POOR Todd Engelsen, President, PEER Servants

ABSTRACT Microfinance generally focuses on the transformation of the materially poor. While the materially poor may lack financial resources, they often have many strengths not as prevalent among the materially non-poor. If approached with mutual transformation in mind, microfinance can be a means through which both the materially poor and non-poor can experience transformation. This paper focuses on the experience of PEER Servants, a Christian microfinance organization that partners with indigenous microfinance institutions around the world serving thousands of microentrepreneurs. PEER Servants lends it services to these partnering MFIs primarily through volunteers from the materially non-poor world. The end result is not only stronger MFIs serving more entrepreneurial clients, but transformed lives among the PEER Servants volunteers as well. KEYWORDS: microfinance, transformation, partnership, volunteer, reciprocity INTRODUCTION As the President of a Christian microfinance organization, I am privileged to see exciting transformation among the materially poor. Many of these micro-entrepreneurs are nothing short of amazing. They are willing to take the risk of tarnishing their reputation by borrowing capital to start or grow a small business. Consider the following real-life accounts… Kikielomo is a chicken farmer in central Nigeria. She approached Good Seed Enterprise Development, a local microfinance institution, to get a $75 loan to buy 150 chicks that she would raise during the high-risk period and then sell to other chicken farmers to raise from there. Business did not start well for Kikielomo – the 150 chicks she was supposed to receive ended up being only 75, but Kikielomo was not deterred. She repaid the $75 loan, qualified for successively larger loans, and grew her business. Two years hadn’t passed before Kikielomo had 2,000 chickens. She was now also selling them to local restaurants, and she had started a fish farm. Kikielomo had experienced financial transformation, but her story doesn’t end there. Her real dream in life was to start a private Christian school for the many children in her urban neighborhood whose parents could not afford to send them to school. She opened Diamond Private School and welcomed 150 of those children from the urban slums. Her business and the microfinance capital made available to her to grow the business allowed her to subsidize the cost of the education so that every child could get an education. As importantly, it allowed Kikielomo to realize her dream to be an agent of social and spiritual transformation in her community. Vasile was unemployed in a small village in the former Soviet republic of Moldova. The Soviet social structure with which he was familiar had not prepared him to become an entrepreneur, so he didn’t run to the door of Invest Credit, the local microfinance institution. But his wife, Olga, did. Olga made beautiful tortes and she qualified for a $100 loan to expand her cake-making business. Despite how beautiful and delicious each of those tortes was, their little village of

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4,000 people didn’t have a sufficient number of weddings and other celebrations to allow the business to succeed. They still repaid the $100 loan. While the loan didn’t launch a successful business, it did convince Vasile that they could do business. He qualified for a $300 loan to buy some pigs, butcher them and sell the pork, head and all, in the local market. Vasile did well, and as he qualified for larger and larger loans, he was able to buy a used truck to lower his transportation costs and take additional steps to transform the business from buy and sell to manufacturing – producing some of the best sausage in Moldova. Vasile eventually qualified for loans in excess of $10,000 and had more than twenty full- and parttime employees. Through this Vasile was able to give generously to his church, hire and pay others tied to the church, and enable the church to more effectively reach out to the needs of the community. In addition, Vasile donated some of his sausages to the local orphanage for the children to get protein in their diet. Vasile had become an agent of financial, social, and spiritual transformation in his community. Flydah was living in a South African township selling not more than a few minerals (soft drinks) a day from her home. She knew she could do business, but she lacked one thing – capital. In stepped Aloga Financial Services, the local microfinance institution, and offered Flydah a $300 loan to establish her catering business. Soon Flydah was catering most of the events of her church and other activities in the community. Her excellent repayment record allowed her to eventually qualify for loans large enough to open a small restaurant. Flydah needed a growing number of employees, and she had high standards for her employees. Much as Aloga Financial Services had looked at her and seen the potential, she wanted to look at others and see their potential. She hired David and Moses, two mentally-challenged young men. According to Flydah, they could peel potatoes for her chips with the best of them. Flydah didn’t stop there. She knew how to make beautiful beadwork, so she developed that business and started exporting thousands of pieces of her work to Japan and other countries. She knew many of the other women in the township were out of work, so she started training them in how to do the beadwork and enable them to start generating income. In so doing, she discovered how much she loved training, so she combined her loves of training and helping those society had caste to the side by securing some government tenders to train prisoners in the local jail. She started with the beadwork – today, ornaments made by those prisoners are hanging on Christmas trees around the world. She added butchery and catering to her training to prepare prisoners for making an income upon their release. She showed such love and concern for the prisoners that they threw her a surprise birthday party fully catered by them. Is it any surprise that Flydah, the woman who had been sitting at home selling an occasional soft drink here and there, would soon be recognized as the Greater Pretoria Small Business Woman of the Year?! As these stories attest to, done well, microfinance can offer a means to financial, social, and spiritual transformation for many of the materially poor. But if transformation stops with the materially poor, we have short-changed and underappreciated the power of microfinance. It would be like driving in to a Krispy Kreme with the neon light on and insisting on yesterday’s donuts. It would be like attending the University of North Carolina at Chapel Hill and never shouting at the top of your lungs to support the Tar Heels in a basketball game at the Dean Dome. For people of the Christian faith, it would be like claiming to be a Christian without ever experiencing the adventure of following the life of Jesus. Microfinance can transform not just the materially poor, but the materially non-poor as well. It can, and in its most effective form must, transform each of us.

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KEYS TO TRANSFORMATION AMONG THE MATERIALLY NON-POOR That leads me to the story of PEER Servants, the organization of which I am the President. Now I firmly believe that if you want the real PEER Servants story, don’t listen just to me. I, like most heads of most organizations, see the entity much differently than some of our volunteers or microfinance partners may see it – I may have a difficult time differentiating between what I want to see and what really is there to see. So, while I will attempt to paint a realistic picture, you must appreciate that my vision for all I want PEER Servants to be may cloud the real picture. If there is anything worth looking at, it is the result of a very merciful God who refuses to give up on us until we do this well and some amazing volunteers and microfinance partners who have established mutually enriching relationships and work very hard to bless and be blessed by the materially poor. The mission of PEER Servants is “to transform lives by partnering for economic empowerment and renewal”. One may look at that and conclude we are just one of many organizations, and small at that, that are trying to empower the materially poor. PEER Servants is that and more. The mission statement’s final word, “renewal,” refers not just to the renewal we hope to see among the materially poor, but among us, the materially non-poor. Our mission is as much about the transformation we hope to see among us as it is among anyone else. How do we attempt to pursue that twofold mission? There are three key factors to our strategy - -partnership, volunteers, and reciprocity. Partnership PEER Servants only works through microfinance partners. These are Christian organizations indigenous to the materially poor world that have a vision for empowering their own people. They somehow hear about PEER Servants, acknowledge their need for a partner like PEER Servants, and invite us to partner with them. PEER Servants never steps into a country and announces “this place needs microfinance - who will partner with us?” Nor do we ever establish our own microfinance program within the country. We are not microfinance practitioners, per se, but more technical assistance providers and donors to the MFIs with which we partner. They are the senior partner – we are here to serve them and help them realize their own vision which we happen to share. They establish their own annual plans, identify their top strategic initiatives within that annual plan, and then invite PEER Servants to help them with some or all of the initiatives. The services we attempt to provide them include: • • •

•

consulting (e.g., helping them design their own microfinance programs, identifying tools like management information systems that will help them grow their program, etc.), training (e.g., training board members in effective governance, staff members in risk management, and, working with the staff, preparing client curriculum on relevant business training or spiritual encouragement topics), capacity building (e.g., helping them implement procedures and applications of technology to grow their microfinance programs to the point of becoming sustainable and more transformational, networking them with larger organizations in the PEER Network to learn from them, etc.), resource development (e.g., providing start-up and growth funding in the form of grants, while also helping them better market themselves to attract other technical and funding partners through the creation of marketing materials, websites, etc.), and

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•

spiritual integration (e.g., helping them realize their own vision for their clients to better understand the love Jesus has for them and how that should affect even the way they do their business and those they bless through their business).

A partnership model is essential if the materially non-poor are going to also experience transformation. Western microfinance organizations cannot use traditional models wherein we enter a materially poor part of the world in the position of power and control and expect to be transformed ourselves. A complete analysis of what goes into successful microfinance partnerships goes beyond the scope of this paper, but based on our experience, a successful partnership model that will allow for the transformation of the materially non-poor requires at least the following: •

Relationship: Any successful partnership starts and ends with relationship. This is a huge challenge for those of us from the West because it’s not our strong suit. We’re good at programs, strategizing and such, but we find relationships challenging. Relationships within our own cultural context are difficult; all the more relationships that cross cultural boundaries. While relationships are difficult for us, they come much more naturally for our partners in the materially poorer parts of the world. At PEER Servants we spend at least two years building what we call our “foundation of fellowship” before formally entering any partnership. Taking the time to establish that foundation builds strong trust that will allow the partnership to survive the certain bumps that will occur when running a microfinance program. That means we have a strong relationship in place before there is any exchange of funds, any micro-loans made, and any stories of transformation written. Focusing on relationships also starts the process of transformation taking place among those of us who are the materially nonpoor -- we come to know and love the board, staff, and even clients of our partnering MFIs as people, not just a means to hit a certain goal. We start to appreciate the relational strengths of the materially poor and the joy they experience as a result, and appreciate relationships are but the tip of the iceberg of many strengths the materially poor have that the non-poor often do not.

•

Time: We have to take the time to help the microfinance partner build strong governance structures and the capacity of their management and staff. In much of the world, and often our own part of the world, sitting on a board is seen as an honor. A transformational MFI requires a very active and engaged board. It will take most board members some time to figure that out. Encourage boards to enforce board terms to get new blood on the board and the right people to help grow the organization. Encourage subcommittees within the board so that the board is addressing all of the areas the MFI needs without stretching each board member too thin. Resist the temptation, even if asked, to join the board of an indigenous microfinance partner – based on what we have seen, one Western donor is a majority on most boards of indigenous microfinance organizations. You will thwart the very transformation you are there to help effect. Time is also needed to build the capacity of management and staff. Often the Executive Director who is the right person to start a microfinance organization is not the right person to grow a microfinance organization. If a strong board is in place, the organization can make it through leadership changes. The MFI will generally start smaller and remain smaller for some period of time as capacity is built in the board, management, and staff. That means you need to start with a smaller group of informed donors who support the concept of partnership and are willing to see longer-term returns in their investment. If you or your donors want immediate significant growth in number of clients receiving loans, don’t pursue a partnership model. But realize in so doing you may be forfeiting the model that will reap the most rewarding longer-term returns in the lives of the materially poor and the materially non-poor.

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•

Accountability: Partnership requires mutual accountability. That includes regular updates and robust reports from the MFI, onsite visits by the supporting partner, and periodic formal assessments to communicate clearly the achievements and shortcomings of the MFI. But mutual accountability also includes allowing the MFI to hold the supporting partner accountable. All too often we over commit and under deliver as Western organizations, at least in the minds of our partners who are on the front lines of empowering the materially poor. Be careful what and how you communicate and make certain to deliver on that to which you commit. Often an indigenous microfinance partner in the materially poor world will need to have funds in their bank account before they will take the next steps towards project completion. We live in a part of the world where electricity, internet, banking, etc. work efficiently – the stakeholders of your microfinance partner may not. Consequently, they place a higher premium on having resources in hand. Also, give serious consideration to what your organization pays your own staff relative to the salary levels of the partnering MFI. Western staff certainly needs a sufficient income on which to live, but we are making a mockery of partnership if we have Western staff with salaries that are many multiples of the local staff’s salaries. At PEER Servants, we have found that mutual accountability means it is important to extend the accountability to our personal lives as well. Occasionally our PEER Servants associates have greater personal financial assets than the MFI they are serving. Being in a close accountable relationship with someone(s) in the materially poor world should lead to simplifications in our own lifestyles.

The partnership model is one where the Western organization enters the partnership as the supporting partner and creates a structure that will empower the stakeholders associated with your microfinance partner to invest in the transformation of the materially non-poor associates and donors of the Western organization. Such partnerships can succeed in transformation of the materially poor and non-poor if they incorporate a foundation based on relationships allow sufficient time to build the capacity of the MFI, and insist on mutual accountability between the partnering organizations. Volunteers While PEER Servants works only through microfinance partners, it also works almost exclusively with volunteers. The microfinance partners have full-time staff paid out of their operating revenues, but with the exception of less than a handful of paid employees, PEER Servants utilizes the availability of volunteers to serve the microfinance partners and many of PEER Servants’ corporate needs as well. These volunteers are people very much like you – busy people trying to juggle a professional or academic life with all of the demands of family, friends, church, etc. They may not be able to give up their day job, but they want to do something fulfilling that would bless others, especially the materially poor. The vast majority of our volunteers are very dedicated – offering many hours a month in serving the microfinance partner or PEER Servants. We have found this model of using volunteers, while having many challenges, to be particularly effective at enabling us to achieve the second half of our mission, renewal, and encouraging transformation of the materially nonpoor. With this commitment to the second half of our mission in mind, some of the advantages a primarily-volunteer model brings include the following: •

Impact: Each volunteer brings only a certain amount of bandwidth to the time they can volunteer at PEER Servants. That means PEER Servants needs a lot of volunteers to effectively serve our microfinance partners. As dedicated as they are, realistically it takes 4-8 volunteers to achieve what one full-time staff person may be able to achieve. Why do we stick with the primarily volunteer model? Because it helps us better achieve renewal of the materially non-poor, the second half of our mission. The larger number of volunteers each experience

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transformation in their own lives by working more closely with our microfinance partners or other volunteers in PEER Servants. They come to a renewed appreciation of the powerful position of being a servant as opposed to the boss, controller, or other superior position coming from the West. They also come to appreciate the strengths that our materially poor partners have and learn to focus more on those strengths than their weaknesses. They become “converts” to the perspective that the person who wants to lead must serve. Not only do they experience personal conversion, but they go to their families, friends, churches, workplaces, and other spheres of influence as evangelists with this message that their lives have been enriched, thereby preparing the way for others who are materially non-poor to experience transformation as well. •

Organizational Culture: Volunteers are in PEER Servants because they want to be there. There are no financial incentives – in fact, quite the contrary as many of our volunteers are our most generous donors. They are willing to give what is one of the most precious assets they have – limited free time – to serve within PEER Servants. Entering the organization in this manner and being freed from behavior driven to material gain creates a very unique culture within the organization. It fosters a culture of humility, service, and mutual accountability wherein we are encouraging each other to be transformed. As a Christian organization, our common desire as volunteers within the organization is to become more like Jesus and to enjoy the adventure together of following in His footsteps. Our microfinance partners notice this right away. Many of them have commented to me how amazed they are with the attitude of the PEER Servants volunteers relative to their experiences with staff from some other Western organizations. This culture within the organization encourages the ongoing transformation of our materially non-poor volunteers.

•

Skills: Volunteers come to PEER Servants from their respective workplaces as accountants, IT professionals, marketers, educators, investment bankers, pastors, and many other vocational backgrounds. They bring with them a skill set that would be very expensive for PEER Servants to try to develop with a much smaller full-time staff. As a volunteer applies his or her given skill in serving a microfinance partner, they often develop a desire to further refine and develop that skill so that they can more effectively serve the microfinance partner. This leads them to becoming an even more valued employee to their employer as they return to the workplace with a greater desire to learn and perform well. Sometimes more socially conscious individuals feel they are somewhat of a “sell out” if they go and work in the for-profit world applying their skills to just getting a paycheck. Involvement in PEER Servants allows them to apply their skills to benefit the materially poor and thereby experience a renewed appreciation for the skills they have and that their employment has enabled them to develop. The transformation of the materially non-poor extends back to the very thing that may have been frustrating them most in life by making the unfulfilling job more fulfilling.

As PEER Servants grows, it will need to add more full-time staff positions, but it will do so only to better manage and support the efforts of our volunteers and not replace or restrict them. In so doing we will maintain a model that better lends itself to the renewal of transformation of the materially non-poor. Reciprocity The third factor in PEER Servants’ strategy to effect transformation among the materially non-poor is what we call reciprocity. It’s a conviction that not only are we all made in God’s image, but God gave each of us strengths with which we could enrich each other. Microfinance rightfully focuses on issues of operational sustainability, financial

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

sustainability, and institutional sustainability, but reciprocity refers to what may be the most important form of sustainability to lasting and long-term transformation, and that is relational sustainability. I have had countless people approach me throughout the years and state something to the effect of “I want to do something to help the poor”. My general response to them has been the most effective way they can give to the materially poor is to learn to receive from them. They must, over time, identify those areas in their own lives where they are lacking and then, by coming close to the materially poor, look for ways to learn from them. That is how we create relational sustainability, by acknowledging and discovering that we need each other. No one, including the materially poor, likes it when someone approaches them with the attitude of “You need to be transformed, I am here to help you do it.” What is much more effective, especially for the materially poor, is when you approach them with the message “I need to be transformed, and God has given you some strengths which will enrich me.” If you approach the materially poor in any way communicating the former message, it doesn’t matter how large a loan you have given them, you will have left them more impoverished. If you approach the materially poor communicating the latter message and complement that with access to loan capital, business training, an awareness that God wants to bless them so that they can bless others, and the tools they need to fulfill their dreams, you will have helped develop a powerful agent of transformation in the lives of others within their community and in your life as well. You will see countless Kikielomos, Vasiles, and Flydahs that we read about at the beginning of this paper. If you have not yet walked closely with the materially poor, you may question what strengths they really have. Again, to address that topic fully goes beyond the scope of this paper, but at PEER Servants we have witnessed all of the following and more by walking closely with them: • •

•

Community: The materially poor have much stronger community than we do in the West. We are trying to establish that kind of community within PEER Servants – to take time to really know and care for each other. Perseverance: The materially poor have to persevere and overcome great odds. Remember Flydah? Her restaurant has been broken into by thieves many times – one time even taking her deep fat fryer! But Flydah persevered and, consequently, achieved her current level of success. Joy: Joy seems to be in short supply among many of us in the West. If you want to tap into large reserves of joy, spend time among the materially poor. They have learned the truth that wealth comes from appreciating what you do have while poverty results from wanting what you don’t have. Generosity: This, too, may surprise you – how can the materially poor be so generous given what little they have? And yet time and time again, we have seen the materially poor forego material comfort in the interest of being generous to others. Consider Kikielomo – she could have directed her profits to living in a larger house and getting a nicer car, but she directed her profits to helping those who were even materially poorer than she. Gratitude: The materially poor are extremely grateful. We have so much in our part of the world that we take things for granted and forget to express our gratitude. We fool ourselves by thinking our position in life is primarily the result of our hard work, blind to the fact that we were born into an environment which was a major contributor to allowing us to become who we are today. The materially poor are teaching us how to be a more grateful people, to each other and to our God.

The list of strengths of the materially poor goes on and on. Followers of Jesus will be particularly enriched by their materially poor brothers and sisters in Christ as they witness their worship, their desire to tell others about Jesus, and their ability to love and forgive. As you start to focus on it more, you can appreciate why PEER Servants would have “the

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

reign of reciprocity” as what it considers one of its most strategic core values, particularly as it relates to the transformation of the materially non-poor. Partnership, volunteers, and reciprocity – these are the three key factors PEER Servants has adopted as part of its strategy to fulfill its mission to witness transformation not only among the materially poor, but the materially non-poor as well. CONCLUSION I started this paper with three stories of transformation among the materially poor. Given the focus of this paper, it is only appropriate I should end it with three stories of transformation among the materially non-poor. Stella held a senior marketing position at a Fortune 100 company and had just returned from a successful business trip to the West Coast. Feeling particularly good about the outcome, she treated herself to a trip to the jewelry store where she bought a beautiful pair of earrings. Shortly after her return to Boston she attended one of her first PEER Servants gatherings. She was attracted to PEER Servants given her desire to use her marketing skills to help build PEER Servants and the microfinance partners it served. At that gathering, a Nigerian pastor spoke passionately to the PEER Servants volunteers, encouraging them in their service to the materially poor and ultimately to Jesus Himself. Stella was very moved by the message and couldn’t get her mind off the earrings she had just bought. She didn’t need them and, relative to the impact she could have in empowering the materially poor, knew that it had been a very poor investment. The next week she returned the earrings and directed the funds, thousands of dollars (a very expensive pair of earrings!), to empower the materially poor. Beyond the wise investment, she came to a renewed appreciation that the material things she bought were not a great source for lasting joy. After taking just a step or two closer to the materially poor, Stella was already experiencing transformation! Sally was a training consultant by profession and had been a very active PEER Servants volunteer for almost three years. She had never been to Africa before, but decided to take a trip to Nigeria to work with the microfinance partner there. Given the limited news reports she had heard, Sally was both fearful and excited about going. A couple days into the trip, the vehicle Sally and her traveling companions were in had a flat tire. Sally knew how she dreaded the flat tires she had experienced back home, but all the more when there wasn’t an AAA to call and they were in an unfamiliar environment. What Sally saw in the minutes to come was just one way she was enriched through the trip – she saw community. Other Nigerians stopped and joyfully helped in changing the tire. The car was operating again only to run out of gas just minutes later. A Nigerian gentleman on his motorbike stopped and very willingly went to the next gas station to get a container of gas and bring it back to them. The traveling companions made it back safely to where they were staying. To this day they talk about the richness of Nigerian community they witnessed on that day, while committing themselves to bringing more of that community back to their own communities. The greatest story of transformation among the materially non-poor with which I am familiar is my own story. I entered this community development space thinking I would be the means through which the materially poor would experience transformation. I never saw what was coming. Eventually I discovered that it was the biases in my culture, the overemphasis on material well-being that led me to a needs-based perspective towards community development among the materially poor. Needs-based community development isn’t very effective. What I found to be much more effective was what Steve Corbett and Brian Fikkert identify in their book “When Helping Hurts” (2009) as “asset-based community development,” where we enter a community acknowledging the many strengths they have, building on them, and even

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

being enriched by them. My wife, Leslie, and I often look at each other and question whether we are some of the richest people in the world. It’s not the result of what’s in our bank account! It’s the result of being open to the many gifts the materially poor have to offer us, and accepting those gifts. How have we been enriched? Our South African partners have taught us how to forgive; our northern Ugandan partners how to persevere despite great hardship. Our Filipino partners have taught us how to do better microfinance, and our Nigerian partners how to stand up for what we believe in the face of opposition. Our South Asian partners have taught us how to experience personal peace in the midst of a tumultuous environment, and our Moldovan partners have taught us that great things can come from places many in the rest of the world may not even know about! By seeing and coming to appreciate much of what the materially poor do have, we have come not to fear poverty nor to overestimate the value of having material plenty at the expense of the rest of what life has to offer. Perhaps most importantly to Les and, me, as Christians, we have been blessed by many of the materially poor to see more of who Jesus is and to have our cultural blinders removed that had been keeping us from appreciating more of what it means to follow Him. You probably knew before reading this paper the powerful tool microfinance could be in transforming the lives of the materially poor. Perhaps you now know it can serve as a powerful tool in transforming the lives of the materially nonpoor as well. Going to Krispy Kreme may be a good experience; going to Krispy Kreme when the neon light is on and getting a warm donut is a great experience! Microfinance that concurrently transforms the materially poor and non-poor is a great experience as well. We are seeing it at PEER Servants as we pursue our threefold strategy of partnership, volunteerism, and reciprocity. We hope the world of microfinance will be enhanced by witnessing much more of mutual transformation as well. REFERENCES Corbett, Steve & Fikkert, Brian (2009). When Helping Hurts – How to Alleviate Poverty without Hurting the Poor and Yourself, p. 125-128. Moody Publishers

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

THE NEEDED COORDINATION WITHIN MICROFINANCE Rodolfo I. Beazley, Board member of Asociación Civil Mujeres 2000 1 ABSTRACT Institutionists’ MFIs adapt the business model in order to create a parallel financial system which is similar to the existing one but with some special features for their types of clients. This approach is not a social policy but more aptly can be described as an extension of financial services to people who have been excluded rather than a program for poverty reduction. Welfarists’ MFIs consider their goal to be poverty reduction and empowerment. Their approach instead focuses on depth of outreach to excluded clients and is less concerned about financial sophistication. After analyzing the characteristics of both schemes and the dynamics of the microfinance market, this paper argues that microfinance can be highly improved with some coordination between welfarists and institutionists. With that coordination, a virtuous path can be created permitting microfinance to evolve into a semi-sustainable global antipoverty tool. KEYWORDS: Institutionist MFIs, welfarist MFIs, sustainability, outreach, coordination.

INTRODUCTION For many years there has been a division between institutionist and welfarist microfinance institutions (MFIs) in the academic debate. Jonathan Morduch (2000) called this division the microfinance schism. Nowadays, institutionist´s approach is main-stream not only in academia but also among practitioners. Institutionists´ objective is to give financial services to people who are excluded from the traditional financial system. For this purpose, they want to build a parallel financial system, analogue to the existing one but with some special features for their unprecedented clients. Their main concerns are wide outreach and selfsustainability2. Welfarists’ goal is poverty reduction and empowerment. They are less concerned about financial sophistication and just use financial services as a tool to reach their objective. Welfarists focus on depth of outreach and believe that microfinance is just one ingredient in the wide set of interventions needed. These types of institutions do not pursuit sustainability but rely on donor or government funds. However, uncoordinated interactions between the two groups can lead to harmful outcomes. Currently, microfinance is operating below its potential and far below the expectations and more critical thinking about the microfinance’s goals, instruments and targeted population targeted is needed.

I would like to thank Maria Emilia Vanín for her assistance and Maria Eugenia García Neder for her insights and helpful comments. In this paper the term sustainability refers to the capacity of covering both operational and financial costs. Thus, sustainable organizations do not need grants.

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

This paper analyses both schemes, from their objectives to their characteristics and dynamics in the microfinance market. Later, a harmonious interaction between them is proposed as the only way to transform current microfinance into a semi-sustainable global anti-poverty tool. The paper is organized as follows: Section 1: The Basics uses of concepts of social policy and financial deepening to understand the different objectives of institutionists and welfarists; Section 2: Institutionists: The Business Model presents the institutionists’ approach as a business model and analyzes the implications; Section 3: Welfarists explains the welfarists´ approach and shows the reason why it is viewed as inefficient; Section 4: The Microfinance Paradigm goes deeper into some aspects of the microfinance phenomenon including the tradeoffs between sustainability, outreach, and impact, along with the supply-side effects, the issue of over-indebtedness and publicity by these institutions; Section 5: Coordination proposes a reachable coordination that will solve the problems mentioned in previous sections and will allow microfinance to be a semi-sustainable global anti-poverty tool; and Section 6: Summary and Conclusions provides a brief summary of the outstanding conclusions. THE BASICS Both Institutionists and Welfarists claim that their ultimate goal is poverty reduction. This shared objective seems to be quite surprising because differences between them are irreconcilable. Woller et al (1999) show that the practical implications of those differences are the following: 1. differences in the population segments served; 2. differences in the designs; and 3. differences in the institutional structures and financing to support these services. Digging into the basics will clarify the real goals of each type of MFIs but first, the role of microfinance as social policy is presented then the financial perspective is emphasized. Social Policy From a public policy point of view, social policy implies a redistributive component. Even if it is not the aim of this paper to discuss what social policy is, it is known that governments base their social policies on redistribution. For instance, social assistance programs are financed with general revenues. Thus, redistribution is the starting point. Similar to this is the dynamic within pensions’ pillar 1 scheme and non-contributory health systems. In general, social policy consists of redistributing resources. This goal is not exclusive to government organizations. NGOs raise funds from the wealthiest and invest them in the poor. In addition, multilateral organizations use resources from developed countries and the donor community to help developing countries. This approach is a sort of Robin Hood approach. Redistribution also implies that social services should not be charged for or at least they should be highly subsidized. A good example is health insurance coverage which is limited in almost all developing countries and in some developed as well. In order to help people cope with health shocks some governments have launched public insurance (i.e. Colombia, Mexico and United States, among others). Because the original problem was that some families could not afford private insurance, public insurance became free or highly

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

subsidized and result in a form of social policy. On the other hand, charging for services (i.e. public health) would be the same as selling any product and there would be no redistribution. By offering such services to the poor it is the same as providing services in any new market and there is no social policy. Consequently, social policies that aim to reduce poverty are necessarily based on redistribution. This is true whether it is done by public or private non-governmental intervention. If reducing poverty is the MFI’s goal they can also be seen as social policymaking and should be aware of the redistributive component. However, social policy leaves little room for sustainability. Sustainability undermines microfinance’s social policy role in two ways. First, sustainability means that institutions have to cover the costs of their services for their clients. This is why sustainable institutions have to charge high interest rates. Second, there is no Robin Hood approach or the redistributive element is missing. Because of this institutions that strive for sustainability do not consider their services a form of social policy. Moreover, even if they were to contribute to poverty reduction, this is not their ultimate goal and is sometimes hidden behind fancy anti-poverty slogans. By pursuing sustainability institutionists do not aim to reduce poverty. So the next step will be to explain their goal and then elaborate on the consequences of sustainability3. Financial deepening Now that it is revealed what institutionist MFIs are not aiming for the next step is to reveal their true goal: to provide financial services to people who are excluded from the traditional financial system. This is not a trivial goal because people are excluded for a variety of reasons; they might be insolvent, or do not have formal jobs or collateral, or they may live far away from a bank office. Thus, trying to provide them with financial services is a challenge and services must be adapted to meet their needs. That is the basis of the microfinance revolution. Institutionists want to build a parallel financial system which is the similar to the existing one but with special features for their clients. They emphasize the necessity of financial deepening and care about giving their clients a wide variety of financial services, some of which are quite sophisticated. Since welfarists consider financial services as a tool for reaching their goals they care less about financial deepening.

INSTITUTIONISTS: THE BUSINESS MODEL

Institutionists approach is business oriented. They use the techniques and philosophy of business and adapt them to their market. The starting point of business is sustainability and is also the cornerstone. That means

Regarding micro-insurance schemes, they are sustainable and charge for their services as well. However, there is no conflict with their ultimate goal, as they do not strive for poverty reduction but for extending insurance’s services.

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

setting the right prices, finding the suitable market, taking advantage of the economies of scale, having access to capital markets, and publicizing their services.4 As this section will argue, institutionists apply these concepts to microfinance and this has resulted in some undesirable consequences.

Sustainability Because institutionists pursuit sustainability, even if it is feasible, giving small loans to risky people can jeopardize this. That is the reason why traditional banks do not give credits to poor people. Furthermore, some of these institutions have huge cost per clients, because reaching the excluded can be costly. For instance, opening a new branch in a remote area may mean inefficiencies that can jeopardize sustainability. Because they are trying to be sustainable these institutions need to increase both the size and the quantity of loans in their portfolios. Bigger loan amounts require greater capacity to pay back and that means lending to clients with more income and those who are less poor. As a result, these institutionists tend to provide loans to people who may be excluded from the financial sector but are still better off5. Moreover, by increasing the quantity of credits to those types of clients, these organizations also employ many of the cost-reducing profit maximizing strategies of traditional banks. To cover their costs some microfinance institutions are charging interest rates above market rates6. Yet even when they earn higher rates of interest on larger loans they are still small compared to the traditional financial system. Setting the prices High interest rates are the Achilles' heel of microfinance. This issue has been receiving a lot of criticism, especially from policymakers. Institutionists have two reasons for justifying such high interest rates. On the one hand this is a way of reaching sustainability. That is not rocket science. Fernando (2006) basically argues that this is because micro-lending remains a high-cost operation. This rationale is correct. On the other hand, according to the Consultative Group for Assistance to the Poorest - CGAP - (1995): “MFI charging very high interest rates almost always find that demand far outstrips their ability to supply it. Most of their customers repay their loans and return repeatedly for new loans: this pattern demonstrates the customers’ conviction that the loans allow them to earn more than the interest that they have to pay”. For the past ten years, the author of this paper has been asking in conferences, courses, and (more recently) Internet newsgroups whether anyone present has ever heard of a microfinance program that ran into trouble by driving away clients with interest rates that were too high. No one has yet pointed to a single example. This does not indicate that there is no limit to the interest rates that the microcredit market can bear, but it does

All the concepts but publicizing the service are developed in this section. In relation to publicity, this is analyzed in section 5, as it has direct implications in both schemes. Regarding the analysis of microfinance as a business model, it is useful to express that as any successful businessman, institutionists know how to publicize their services. 5 See subsection Economies of scale. 6 Fernando (2006) and CGAP (2003).

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

suggest that the limit is probably considerably higher than what even the more aggressive MFI are presently charging. This quotation is provoking. It is true that interest inelasticity is high7 and that profit maximizing behavior implies that MFIs should take advantage of this and set the highest rate possible. However, implying that huge interest rates are viable because they meet demand seems to be a polite way to support taking advantage of the poor. This rationale is clearly not pro-poor, even if it allows sustainability and growth of those organizations. Likewise, that rationale can also justify usury. But institutionists need both arguments. If only the sustainability argument would be the answer people might react by saying: so do not be sustainable. That is exactly how the second argument arises; since institutionists are basing their approach on a business oriented rationale when supply equals demand those rates are viable.

Economies of scale Because of economies of scale, raising interest rates is not the only the path to broadening outreach and increasing loan amounts. With more clients who can afford the higher rates MFIs can earn more revenue at the same or lower cost. These factors induce MFIs to target non-poor population or at least the non-chronicallypoor population. Those kinds of clients not only have more income and less indebtedness but also are often easier to reach because they live in urban areas8. Capital markets Institutionists also believe that worldwide successful poverty reduction requires them to operate on a massive scale. Doing so requires massive financial resources and this kind of global intervention cannot rely on scarce and fussy donors. However, how can such a costly system be self-sufficient? The answer is by having access to private capital. To do this, MFIs need to meet a lot of requirements, the most important of which is to be profitable. Therefore, the rationale is that MFIs must be sustainable to reduce worldwide poverty. But this rationale has a core failure because the argument relies on minimizing the number of poor people or people below the poverty line. So when you have to consider income the rationale fails. If institutionists MFIs cannot reach the poorest they cannot reduce chronic poverty. Instead of focusing on the number of poor people they are focused on the income needed to bridge the poverty gap. Thus this system is not working properly. Concluding remarks about institutionalism Institutionalists copy the business model that rejects the clients that they are trying to attract. That is the reason why some institutionalist lobbyists have no history in anti-poverty programs but an extensive record with

7 8

See Aghion and Morduch (2005). Amin et al (2003); Gulli and Berger (1999); Navajas et al (2000); Schicks (2007); Zeller and Johannsen (2006).

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

financial organizations. As we all know, their business model has some social problems and it is surprising that institutionalists try to solve those problems by using the model that had created them. In words of Morduch (2000), institutionalists MFIs have established the win-win proposition: “Microfinance institutions that follow the principles of good banking will also be those that alleviate the most poverty. By eventually eschewing subsidies and achieving financial sustainability, microfinance institutions will be able to grow without the constraints imposed by donor budgets. In the process, according to the argument, these institutions will be able to serve more poor people than can be served by programs fueled by subsidies”. If the argument is right, much poverty alleviation can be achieved at no cost to governments or donors and even earn a small profit. However attractive this of win-win proposition fails. In order to be a massive instrument for poverty alleviation, institutionist MFIs need to have access to capital markets. Thus, they must be sustainable. But sustainability requires broadening the outreach, increasing loan amounts and targeting clients with higher incomes than the chronically poor. Consequently, this new financial system helps some poor people who have incomes that exceed the poverty level and is not a solution for alleviating core poverty. Moreover, this scheme presents some other problems as it tries to reduce poverty without having a redistributive component. WELFARISTS Welfarists’ goal is poverty reduction and empowerment. They know that poverty is multidimensional and that financing is not the solution. They are also aware that sometimes, in order to produce an upgrade in life conditions, credit services should be mixed with other interventions. This implies providing services that are more personal but also may be less effective from an economic point of view. The welfarists’ paradigm is mainly used by NGOs and governments. This approach focuses on depth of outreach and it is less concerned about financial sophistication. It uses financial services as a tool to reach their objective. A common question in the debate is “why do welfarists reach the poorer?” Three are the main reasons. First, the welfarist approach is designed to reach the poor. They offer community based services that are meant to attract poorer clients9. The financial services are complemented with other training and support that the poorest need. Welfarist financial services are part of a wide range of social services that NGOs or governments offer. Thus, holistic assistance is provided. Second, because welfarists do not pursuit sustainability, they do not need to take advantage of the economies of scale and they can adapt loan sizes based on the needs of their targeted population. Third, because their efficiency is measured in terms of impact and not with regard to 9

Welfarists lending services are still similar to those from the microfinance pioneers, meaning that they are community based. The two most popular lending approaches are the following: solidarity groups and village banks. The former uses the client group as a way of guarantee. These groups tend to be integrated by 5 to 10 beneficiaries, they are managed by staff from the organization, and all the rules are set by the institution. The village bank is owned by the members, but ownership is not formally registered. Members have some level of decision among the rules. Average size goes from 10 to 50 and they are self-managed. Unlike institutionists, welfarists are still highly relying on lending services. This is due to their legal constitution; many countries’ regulations do not allow NGOs to receive deposits. Thus, they cannot offer services like savings accounts or insurance. Welfarist organizations tend to be credit-only institutions.

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

financial objectives, welfarists are not concerned with whether their performance if reflect poorly by financial indicators if it means they are reaching the targeted population. For instance, welfarists would tolerate having a reasonable but bigger delay in the repayments. They accept that there is a tradeoff between targeting the poor and good financial indicators since the poorest may be the worst clients10. Welfarists choose to target the poor and their institutions may have poor indicators of financial performance and Institutionists choose the opposite because they have to be sustainable in order to have access to capital markets. Because welfarists conceive microfinance as a social policy they use it as a redistributive mechanism. Welfarists MFIs rely on grants or government funds, thus, the Robin Hood approach, taking money from the wealthiest (donor community) and investing it in the poorest. Welfarists do not charge their clients and this is the other side of the redistributive component11. This kind of organization is often viewed as inefficient and there are many reasons for this. Welfarists do not try to maximize the profits on the financial services they offer but want to maximize the impact they have on poor people. For this reason, they provide their clients complementary services like training on business skills, among others. Thus, when evaluating the efficiency of welfarist MFIs the focus is placed on the impact and not on the financial services. According to institutionists non-profit entities are inefficient and as a rule welfarists are perceived as inefficient within the microfinance paradigm. The welfarist approach is implemented by a huge variety of institutions, from big entities or governmental programs that could be sustainable but prefer this approach, to small NGOs that raise few funds and have no control or evaluation of their impact. Across this wide spectrum there are some institutions which may be having a cost-effective impact on the poor12. However, because impact evaluations are very costly and are usually not done because small organizations cannot afford them a huge proportion of welfarist MFIs are working without evaluating their impact. This image limits welfarist MFIs capacity to raise funds. No donor will fund a scheme that is viewed as inefficient. In order to change this situation, welfarists should do two things. First, convey the correct message: efficiency among these organizations should be measured as the impact on the poor. Second, entities that can afford impact evaluations should invest in them. This will be both a tool for the leadership of the institution and a way of showing results. Smaller entities can find alternative strategies. For instance, TNS has recently measured the satisfaction of the clients of the Argentinean MFI Mujeres 200013. This is not an impact evaluation, but it is another way of evaluating the MFIâ&#x20AC;&#x2122;s performance.

See Schicks (2007). They have interest rates, but these are low and aim to balance the portfolio, not to cover operational costs. 12 In this paper the term cost-effective impact refers not only to having impact on the targeted population, but also that the impact is achieved with a cost lower than the benefit. This cost includes the opportunity cost, which means that the impact should be achieved with the lowest-cost alternative. Determining social benefits of a social policy is not easy. Moreover, this kind of impact evaluations is very costly and, sometimes not viable. 13 Results of the satisfaction survey are available at www.mujeres2000.org.ar 11

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

Regardless of the size of the institution, there should be no room for inefficiency in welfarists organizations. Welfarist entities should be aware of the cost of being associated with inefficiency: loss of donor funds and bad reputation and not being able to survive. THE MICROFINANCE PARADIGM The triangle The previous sections show why MFIs face a tradeoff between outreach and sustainability and according to Zeller and Meyer (2002) another source of conflict in microfinance is the trade off with its impact. They developed the concept of the microfinance triangle which shows the tradeoffs between outreach, sustainability and impact.

Figure 1: The microfinance triangle Outreach

MFI

Sustainability

Impact

Source: Zeller and Meyer (2002)

According to the microfinance triangle broader and deeper outreach to the poor requires a tradeoff in financial sustainability. As MFIs strive for sustainability they need to develop better products and demand-oriented

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

approaches that will raise their impact. Since it is one thing to reach the poor and another to have an impact on them welfarist MFIs can fail to impact their beneficiaries (i.e. Zeller and Meyer, 2002, used Malawi’s case as example). Because the problem with this tradeoff is not easy to resolve, this paper argues that it’s the impact that should be the goal. Welfarists and institutionists need to do impact evaluations and show that they are having a positive effect on the quality of life for their targeted populations. Thus, the real tradeoff is between outreach and sustainability. Supply-side effects Interaction between both types of MFI institutions is delicate. As institutionists charge higher interest rates because they are striving for sustainability and grants enable welfarists MFIs to maintain lower rates, subsidies provided by welfarists can have adverse effects on institutionist MFIs. Because they have to compete with welfarist MFIs it forces sustainable market entities to reduce their rates until their businesses are no longer viable (Aghion and Morduch, 2005). Proposed solutions to this problem often rely on reducing the subsidy size or periodicity (Aghion and Morduch, 2005). However, this paper proposes that the donor community should only grant funds to institutions that effectively reach the poor. If this is the case then the populations that will be shared by both kinds of institutions will be small. This solution also gives welfarists’ organizations incentives for being efficient. Creating a highly competitive market for grants will only allow efficient institutions to raise funds and, having limited access to grants, will incentivize welfarist MFIs to operate as closely to the breakeven point as they can. In addition both types of organizations will share a small targeted group: the best clients of the welfarist scheme and the poorest of the institutionist. According to Schicks (2007), sustainable MFIs mainly work with poor people who are somewhat better off and welfarists complain that institutionists take away their best clients leaving them with the poorest and most costly. This reduces their ability to cross-subsidize between stronger and weaker clients. But institutionists desperately need these poor clients because it allows them to show that they are reducing poverty. But this type of problem does not need a solution. Welfarists have to understand that if clients are willing to pay higher interests rates to receive institutionists' services that what they are demanding is another kind of service. In many ways the best welfarists’ clients will graduate and start demanding more sophisticated financial services. Over-indebtedness Little has been written about the negative effects of the lack of coordination on the demand side between entities. A priori, clients will select a financial services provider based on their preferences and other requirements. If a client becomes over-indebted it can have adverse effects both on the microfinance institution and the client. Since clients are often vulnerable people with lots of financial needs and because most have little experience with banking systems and financial services, they can wind up becoming over-indebted. When one institution decides the maximum amount to lend them it often cannot control what clients get from other organizations. When a client becomes insolvent all institutions have to absorb the loss and clients are worse off than before. Publicity

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

Institutionalism is in the main-stream and they are the big entities that rule the microfinance paradigm in the media, academia, international organizations and donor community. They have sold the notion that in order to reduce poverty effectively MFIs need to be sustainable. As any business does, they know very well how to publicize their services. This vision affects the welfarist approach negatively. Since welfarists do not have as much access to media as institutionists their message is not being delivered to the community. Institutionists let the world think that welfarist organizations are inefficient and because welfarist MFIs rely on grants it is limiting their access to funds. Consequently their growth rates are lower than the institutionistsÂ´ and the gap in growth is getting bigger. This vicious circle can be broken. Welfarists need to work together and convey their message. They can create a worldwide union that represents their interests and this will help them gain a place at the microfinance table and open the eyes of academia, international organizations and donor communitiesâ&#x20AC;&#x2122; to raise funds and ensure that they undertake the work that their paradigm establishes. Because welfarists represent between 70 to 90 percent of the MFIs it gives them an advantage and makes the creation of a worldwide union even more necessary.

Figure 2: Microfinance pyramid by type of organization

Source: Grameen Foundation USA (2005)

COORDINATION The microfinance approach can be highly improved with some coordination between welfarists and institutionists. The former should target the chronically poor and only concentrate on using the financial service

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

as a way to have some positive impact on their clients’ quality of life. Because they have to raise funds in a competitive grant market they should provide proof of their impact. Institutionists on the other hand should target non-chronically poor and better offs who are excluded from the traditional financial system and pursue sustainability and provide financial innovation. With coordination a virtuous path can be created because a chronically poor woman can begin by receiving welfarist’s services and get access to financial services and other sorts of assistance (i.e. training). As welfarist’s entities will have tested their impact this would increase her quality of life. This will help increase her demand for higher loans and more sophisticated financial services making her more suitable for financial services by institutionists MFI. Finally her quality of life quality will be so improved that she will be able to eventually access the traditional financial system. In this virtuous path competition is only between organizations within each type of scheme. For instance, welfarists will compete for clients and funds while institutionists could support welfarists in their own areas of interventions. As lots of firms provide support to foundations, institutionists could give grants for financial and managerial training and other kinds of support to welfarists. Institutionists could even give welfarists some type of legal guarantee so that they could offer saving and insurance services. By taking this approach microfinance can become a semi-sustainable global anti-poverty tool. Two examples demonstrate how this is possible. First, the Grameen Bank has a special program for homeless and beggars. Because they do not match the profile of Grameen’s clients there is a special program for them. A program of this type is not sustainable and does not charge interest or have repayment deadlines. This means that within a sustainable institution there are subsidies for people who are poorer than their usual clients. Second, lots of traditional banks have been giving grants and technical support to microfinance institutions. Once again, this means that a sustainable institution is subsidizing a program for people who are poorer than their usual clients. SUMMARY AND CONCLUSIONS This paper argues that there is a hidden business model behind the poverty reduction slogans of the institutionist MFIs. Institutionists aim to create a parallel financial system similar to the existing one and they try to solve social problems using the same model that had created them. This approach is not a social policy but extends financial services to excluded people rather than being a program for poverty reduction. This is because in order to be an effective instrument for poverty alleviation institutionists MFIs need to have access to capital markets. Thus they must be sustainable. Sustainability implies broadening the outreach, increasing loan amounts and targeting clients with more income than those who are chronically poor. This approach helps some poor people who have incomes that exceed the poverty level but it is not a solution to core poverty. Moreover this scheme results in other problems as it tries to reduce poverty without a redistributive component. Only when you take into account that poverty reduction is not the ultimate aim of institutionists can MFIs be highly successful at offering financial services to the excluded. This type of microfinance institution has been growing successfully during the last years not only in quantity of clients but also in the service quality (i.e. savings accounts, insurances, etc). Furthermore, some of them are reaching profitability and others are even becoming sustainable.

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

The goal of welfarist MFIs is poverty reduction and empowerment, which is multidimensional and cannot be solved by financing alone. This approach focuses on depth of outreach and it is less concerned about financial sophistication. They are aware that in order to improve a client’s quality of life credit services should be mixed with other interventions. Thus their services are more personal and may not be profitable. Since welfarists consider microfinance to be a social policy they use it as a redistributive mechanism. They do not charge interest on their loans14 and as a result would rarely reach the break-even point. Thus they need to raise funds from the donor community. The welfarist approach is undertaken by a huge variety of institutions, from big entities or governments that could be sustainable but prefer this approach to small NGOs that have to raise funds and have no control over and make no assessment of their impact. Across this wide range some institutions are surely inefficient in the sense of not having cost-effective impact on the poor. Because impact evaluations are too expensive to conduct (at least for small entities) welfarists organizations need to find alternative ways of measuring their impact on the targeted population because, regardless of the size, there should be no room for inefficiencies in welfarist organizations. After analyzing the microfinance market this paper proposed an approach to microfinance that can be highly improved with some coordination between welfarists and institutionists. The former should target the chronically poor and only be concerned about using the financial services which have a positive impact on their clients’ life of quality. Since they have to raise funds in a competitive grant market they need to measure their impact. The creation of a welfarist union would enhance this development. In addition, institutionists should target the non-chronically poor and better offs who are excluded from the traditional financial system and continue to pursue sustainability and while providing financial innovation. With coordination a virtuous path can be created and microfinance could evolve to a semi-sustainable global anti-poverty tool. With this path competition can continue and welfarists should compete for both clients and funds. However coordination between welfarists and institutionists schemes should prevail where institutionists can support welfarists in their interventions. Lots of firms support foundations and institutionists can provide grants and financial and managerial training along with other kinds of support to welfarists. REFERENCES Aghion, B.A. and Morduch, J. (2005) “The Economics of Microfinance”, Cambridge, MA: MIT Press. Amin, S., Rai, A.S. and Topa, G. (2003) “Does Microcredit Reach the Poor and Vulnerable? Evidence from Northern Bangladesh”, Journal of development economics, Vol. 70, pp. 59-82. Bebczuk, Ricardo N. (2008) “Financial Inclusion in Latin America and the Caribbean: Review and Lessons”, CEDLAS, No. 68. Consultative Group to Assist the Poorest -CGAP- (2002) “Microcredit interest rates”, occasional paper, Washington DC.

They have interest rates, but these are low and aim to balance the portfolio, not to cover operational costs.

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Consultative Group to Assist the Poorest -CGAP- (2003) “Making sense of microcredit interest rates”, Washington DC. Conning, J. (1999) “Outreach, Sustainability and Leverage in Monitored and Peer-monitored Lending”, Journal of Development Economics, Vol. 60, No.1, pp.51-77. Fernando, Nimal A. (2006) “Understanding and dealing with high interest rates on microcredit”, Asian Development Bank. Gulli, Hege (1998) “Microfinance and poverty: questioning the conventional wisdom”, Microenterprise Unit, Sustainable Development Department, Inter-American Development, Bank, Washington D.C. Gulli, H. and Berger, M. (1999) “Microfinance and poverty reduction – evidence from Latin America”, Small Enterprise Development, Vol. 10, No. 3. Hulme, D., and P. Mosley (1996) “Finance against Poverty”, Routledge: London, Vol. 1 and 2. Meehan, Jennifer (2005) “Tapping the Financial Markets for Microfinance”, Grameen Foundation USA. Navajas, S., Schreiner, M., Meyer, R.L., Gonzalez-Vega, C. and Rodriguez-Meza, J. (2000) “Microfinance and the Poorest of the Poor: Theory and Evidence from Bolivia”, World Development, Vol. 28, pp.333-46. Morduch, Jonathan (1998) “Does Microfinance Really Help the Poor?: New Evidence from Flagship Programs in Bangladesh”. Cambridge: Department of Economics and HIID, Harvard University. Morduch, J. (1999a) “The Microfinance Promise”, Journal of Economic Literature, Vol. 37, No.4, pp.15691614. Morduch, J. (1999b) “The Role of Subsidies in Microfinance: Evidence from the Grameen Bank”, Journal of Development Economics, Vol. 60, No.1, pp.229-48. Morduch, Jonathan (2000) “The Microfinance Schism”, World Development, Vol.28, No.4, pp.617-29. Schicks, Jessica (2007) “Developmental Impact and Coexistence of Sustainable and Charitable Microfinance Institutions: Analysing BancoSol and Grameen Bank”, The European Journal of Development Research, Vol. 19, No.4, pp.551-568. Schreiner, Mark (2001) “Seven aspects of loan size”, Journal of Microfinance, Vol. 3, pp.27-47. Woller, G.M., Dunford, C. and Woodworth, W. (1999) “Where to microfinance?”, International journal of economic development, Vol. 1, No. 1, pp. 26-27.

Banking on the Future: Microfinance as Service October 1, 2010 Proceedings

Zeller, M., and R. L. Meyer (eds). (2002) “The triangle of microfinance: Financial sustainability, outreach, and impact”, Johns Hopkins University Press in collaboration with the International Food Policy Research Institute (IFPRI), Baltimore and London. Zeller, M. and Johannsen, J. (2006) “Is there a difference in Poverty Outreach by Type of Microfinance Institution? The Case of Peru and Bangladesh”, Paper presented at the Global Conference on Access to Finance: Building Inclusive Financial Systems organized as part of the annual conference series of The World Bank and the Brookings Institution in Washington, D.C.

ISBN – 13: 978-0-692-01338-0