Variations in Micro-finance Design : Some Important Variables

Par Jens REINKE

Résumé

En Afrique, comme partout ailleurs en Asie et en Amérique latine, le micro-crédit est de plus en plus considéré comme un des moyens de lutter contre la pauvreté. Le présent article essaie de dresser une typologie des institutions de micro-crédit en fonction d'un certain nombre de critères. La zone d'investigation est l'Afrique Australe.

Le groupe de population ciblé par les structures de micro-crédit est constitué des pauvres et en particulier des femmes et des jeunes. Evidemment ce choix a des implications en termes de coût d'intermédiation, même si les populations pauvres représentent un risque moins élevé que les emprunteurs en situation plus aisée. Les petits emprunteurs sont dans une situation économique et sociale quasi semblable et constituent de ce fait une population relativement homogène. Ils pratiquent généralement plusieurs activités à la fois. Le mérite de certaines expériences réside justement dans le fait qu'elles laissent au client la possibilité de choisir librement l'activité qu'il désire financer.

Si certaines expériences sont plus actives en milieu urbain, d'autres au contraire interviennent uniquement dans les zones rurales. La localisation des institutions de micro-crédit dépend en grande partie du segment du marché sur lequel elles interviennent.

Les mécanismes d'octroi et de remboursement des prêts varient d'une expérience à une autre. Si certaines institutions ont encore largement recours aux méthodes classiques, d'autres ont innové.. Ainsi par exemple, certaines expériences en Afrique du Sud et au Botswana ont commencé à utiliser des systèmes électroniques. En ce qui concerne les taux d'intérêt, si la plupart des responsables des institutions de micro-crédit sont d'avis que les taux d'intérêt devraient couvrir les coûts, force est de reconnaître que très peu d'institutions y parviennent dans la réalité.

Contrairement à certaines expériences, d'autres ne mobilisent pas systématiquement l'épargne. Elles octroient des prêts de faibles montants, sans exiger d'épargne préalable. Si en règle générale il est préférable de collecter l'épargne pour financer les crédits, pour des raisons de disparités socio-économiques, il n'est pas souhaitable d'imposer coude que coude une épargne préalable à chaque emprunteur.

Dans beaucoup d'institutions de micro-crédit, l'activité de crédit est liée à un programme de formations. Ces formations contribuent certes à renforcer la capacité managériale des emprunteurs et à améliorer les taux de remboursement, mais comportent des coûts qui alourdissent les charges de fonctionnement. Enfin, pour beaucoup de personnes, micro-crédit rime avec prêts de groupe. La viabilité et les faibles taux d'impayés constatés dans certains cas tiennent en partie à la pression du groupe et à la caution solidaire. Toutefois, on trouve aussi des expériences de crédit individuel basées sur les systèmes de garantie traditionnels qui sont relativement performantes.

1. Introduction

In recent years, the development community came to view microcredit as an increasingly important tool for poverty alleviation and economic empowerment. Internationally, microcredit institutions have grown rapidly in number and size. Noticeably, Africa has been a laggard in this development, and regional microcredit institutions are neither as large nor as advanced as in Asia and Latin America (World Bank, 1996). This paper seeks to identify a list of alternative micro-lending designs and structures, and to stimulate debate about desirable roles and forms of microcredit in relation to the specific needs and constraints in diverse situations.

Microcredit describes seemingly very different forms of financial services offered by equally dissimilar organisations. However, microcredit always refers to credit extended by formal institutions to individuals or informal groups. The formal institution has been set up or is currently financed or supported by donor aid, or constitutes the Œsocial responsibility' department of a commercial bank. Very few microcredit institutions have been transformed into for-profit organisations, and none have been successfully set up as for-profit In most cases, intention of helping them to start or expand an informal business. Microcredit concerns very small amounts; initial loan amounts rarely exceed US$200 and usually are below US$50. Although business development is often a major rationale behind microcredit programmes, microcredit is also used construction, emergency consumption, education and social expenditure.

As an intertemporal financial transaction, microcredit is subject to the problems of asymmetric information, bounded rationality and opportunism. However, microcredit also faces the problem of delivery costs, which are usually neglected in models of financial intermediation in established financial markets. Microcredit deals with small loan amounts, tiny, but frequent repayments, and rapid loan roll-over; therefore, cost-efficient delivery systems assume great importance.

In the following this paper will discuss the implication of various Œdesign' features of microcredit institutions, but it does not intend to provide ready-made answers for the implementation stage. Answers need to be appropriate to the intention of the lender, the institutional and social circumstances in the area of operation, need to take account of opportunities and obstacles that differ from setting to setting. Above all, choices need to be consistent.

2. Defining the Target Group

Micro-lenders are not established merely through the need of poor people, but by the decision-making of donors who first identify a social or developmental objective. Such an objective usually makes reference to the need for credit amongst a specific group of people. On broad terms, we all think of the beneficiaries of microcredit as Œthe poor' or Œthe disadvantaged'.. However, there are important sub-divisions, and there may be problems in reaching the target group.

Some lenders specifically target microcredit at women. Women are usually seen as economically less independent than men in the same social group, and benefits from their economic empowerment are argued to extend more directly to their children. Therefore, women are often seen as more desirable lenders, from a social equity point of view, than men, and there is a large number of microlenders who explicitly aim at women empowerment.

Another important group at which microcredit is sometimes targeted are young people. With high youth unemployment and insufficient job creation by the formal sector, school leavers face disillusion and an unemployed, impoverished youth may well be seen as a threat to the social fabric of society. Hence, creating a perspective, along with income earning opportunities, is seen by some lenders and donors as a priority. Alternative target groups may comprise rural people, because they are seen as unable to benefit from development and employment creation in cities and towns. In fact, much of the debate about microcredit takes place under the title of rural finance, although the two are not necessarily the same. Finally, other social criteria for selecting a target group may be factors such as ethnicity or nationality, or factors of social disadvantage like a physical disability.

Targeting specific sections of the population has not only social but also economic implications. There are two sides to it: first, different groups may be variably efficient in utilising micro-loans in creating viable enterprises, and second, different groups typically have different repayment patterns, thus impacting on the sustainability of microlenders. Therefore, the social desirability of lending to a specific group of people does not imply financial sustainability of lending to them (Reinke, 1998).

In most credit schemes it is found that women are better repayers: they pay more punctually, and they default less often than men. Hence, the targeting of women is not only socially desirable, but also makes economic sense. Lending to youth, though, is different. Young borrowers - those below 25 or 30 years - typically have lower repayment rates than older borrowers. So, while it may be seen as socially desirable to lend to youth, there is a risk premium attached. And not only is it more expensive to lend to youth, they also appear to be less successful in using the loans for setting up viable enterprises. Obviously, it is still justifiable to lend to youth. But, while lending to youth may contribute to achieving a social objective of lending, it is important to be aware that this will probably not contribute to its sustainability.

Reaching the rural poor is difficult: it is expensive to maintain outreach structures in rural settings with poor infrastructure and low population density. However, some research has argued that higher social stability in rural communities aids the reliability of financial relationships. Similar considerations must be applied to any other potential target group that may be identified: Why do we want to lend to them, and what are the social and economic effects of targeting them? Does it impact on the sustainability of the lending programme?

Finally, a lender must decide how to reach a target group. Some lenders restrict their services to women, or youth, or rural communities. Others structure a programme so that it primarily appeals to their intended target group but does not explicitly exclude others. There is no reason why one should exclude men, only because lending to women is a priority. Lending to men can contribute to the viability of a scheme, even when they are not the intended target group. Also, targeting may go wrong: if men are excluded from a scheme, they may decide to send their wives, sisters and daughters to apply for a loan. This may have negative consequences: the Œreal' borrowers is not directly responsible for repayment and thus feels it easier to default; then, the nominal female borrower must make up for it. Not empowerment, but a further loss of control of her own resources could be the unintentional effect of such a loan scheme (Goetz and Gupta, 1996).

3 Economic Characteristics of the Target Group

Microcredit is often associated with small business development. However, money is fungible and small businesses are often practically parts of private households. Therefore, microcredit may find its way into financing projects that the lender is quite unaware of. However, the question should be considered whether credit should be targeted at all at specific activities.

Some credit schemes do not seek to target their loans to any specific use. They may assume that poor people themselves know best how to better themselves, and that some apparently consumptive expenditures may well have investment properties. Critics usually respond that offering consumption credit to the poor may lead them into debt and deepen their economic dependence. Societies with little debt problem but strong entrepreneurial culture may thus be a better environment for offering untied microcredit than societies where entrepreneurial activities need decisive encouragement. The view and objectives of a lender will determine the choice.

More controversial, generally, is the question whether specific sectors are more promising for the establishment of small enterprises, and whether loan availability should be made conditional on the sector identified in a business proposals. Many new business ventures at the micro level are in fact based on trading activities, either hawking or operating tuck shops. Arguably, the establishment of more trading enterprises in specific locations does not increase the purchasing power of their clientele and offers few developmental benefits. More traders thus imply reduced profits for those already in business, and potentially undermines the viability of all. Therefore, so the common argument, microcredit should be directed away from trading activities. Opponents of this view hold that trading is often the start of a more creative enterprise; trading profits can be reinvested into manufacturing equipment. Empirical evidence suggests that such transformation does indeed take place.

Some microlenders start, however, from the explicit objective of furthering manufacturing or skills-based economic activity. While trading may be fully acceptable as a survivalist activity, it is less compatible with industrial policy motives that may underlie micro-lending. Therefore, the objective of the lender should inform the decision concerning the sectoral targeting of credit. Following such a decision about the desirability of directing credit, it should be considered whether it is also feasible: especially in micro-lending to the very poor, it is difficult to vet business proposals and to follow up loan use.. In these cases, targeting is typically inefficient due to the practical problems of enforcing compliance.

4. Location and Branch Network

When designing the lending technology of a microlender, two important decisions need to be made about the role and establishment of a branch network: first, are branches needed, and second, where should they be located?

Decisions about the location of a microlender are often seen as secondary, and largely determined by the intended target group. Many think that if you serve a rural clientele, you should reside in the countryside. If you serve a poor urban clientele then you should operate in those areas in town where hawkers live and artisans work. In many instances, such reasoning leads to poor choices. Cities, and city centres, usually have the best infrastructural connections. From the central bus station of a city or town, one can usually reach more rural people within one or two hours, using public transport, than from any place in the countryside. The city centre is usually easier to reach for a larger number of people than a outlying area.

Obviously, this problem is relevant only when contact with clients is part of the lending strategy. If no such contact is necessary, than location should be determined by cost or convenience considerations. Proximity of lenders and clients is an issue only as long as either clients need to visit the lender, or credit officer have to visit borrowers. Hence, the necessity of maintaining a branch network is determined by the role of follow-up procedures and the choice of payment systems.

5. Payment Mechanisms

The questions about the necessity and location of branches is obviously closely related with the need for finding an appropriate payment mechanisms. Credit extension is, from one angle, the service of getting money out to people and getting repayments back from people: lending is the business of moving money. When microcredit established itself, many practitioners thought of it as Œvillage banking'.. At this time, the image dominated the minds of donors and aid officials of Œcommunity bankers' living in villages and providing services in their neighbourhood. Such community bankers are cash-carrying agents, working on behalf of larger, formal microfinance institutions (Bhatt, 1987).

However, since then, a wide variety of methods have been developed and successfully applied. Cash-carrying credit officers are now the exception rather than the rule (Reinke, 1997). Several institutions have started to use electronic transfer systems to move funds between clients and lender in cooperation with commercial banks which operate sophisticated transaction infrastructure. Such facilities are not available in all developing countries, but they have been successfully used in South Africa and are available in towns and large villages in Botswana. At an intermediate level, postal savings banks exist in most developing countries. Their transaction systems, although typically not as fast and with slightly higher marginal costs, can handle small and frequent payments, to and from every post office.

A well-designed transfer system would not only send money, but also information. When cash is paid to a local credit officer, this officer would need to make a record and send a notice to the relevant accounting office to keep information up to date. In contrast, transfers state their origin, and systems can be designed so that all relevant information is contained on the transfer slip or message. This would enable a microlender to concentrate all book-keeping and data-processing in one office. Typically, the scale economies of data processing are large. Most microlenders could handle all data on a single computer spread sheet, provided that information flows quickly and reliably from borrowers to their accounts unit. There, the state of loans, aggregate and individual, would be accessible at all times, and loan disbursals, monitoring of funds, and financial planning could all be handled centrally. A duplication of such systems in regional or even village offices would almost certainly lead to higher costs and greater informational inefficiencies.

However, the most important benefit of impersonal transfer systems is that they allow to move funds without corresponding travel requirements for credit officers. In countries like Botswana, with long distances and thin population, travel can easily constitute a prohibitive cost in microcredit extension. The benefit of travelling requirement could be reflected in lending strategies in diverse ways: most radical, there may be no staff at all in the field. If, however, field staff or credit officers in proximity of lenders are thought to be important, then they could operate in a purely advisory role, visiting borrowers or groups to discuss problems, reminding them of payments, but never having to disburse of collect cash. This is often argued to contribute to financial prudence and a more efficient flow of information to headquarters.

Employing cash-carrying village level credit officers may still be appropriate especially where no other transaction system exists or where the amounts involved are below the minimum stipulated by banks or other agents. Handling cash, however, increases the danger of theft and fraud and additional costs for book-keeping and the transmission of information processing will be encountered at the level of credit officers. Some institutions limit the negative consequences by having very few, but centrally located branches, so that cash-handling officers never leave the premises.

6. Loan size

Loan size, so is sometimes argued, follows the decision of the target audience: if the very poor are aimed at, then loans should be very small. If the capital requirement of entrepreneurs is high, loans need to be large. This view defines loan size from the perceived loan needs of the borrowers. While there is little to disagree with such a view, it should be considered that loan size is a principle weapon in fighting opportunism: Just the right dose of credit rationing may help to enforce repayments.

Most microcredit institutions use staged credit programming to enforce repayment. Access to future larger loans is made dependent on punctual and full repayment of small initial loans. Such staging requires that entrepreneurs are kept hungry for capital. Loan staging in microcredit is similar to the assessment used by credit-card companies which base overdraft limits, partially, on repayment history. Generally, loan decisions in the micro-field are more similar to those in consumer lending than those in formal business finance. Lenders should not assess the debt - ie repayment - capacity of their clients through analysis of their loan application or their business; rather, debt should be made available according to repayment capability based on current income.

There are instances where credit rationing and staging is not an option; such cases include entrepreneurs requiring capital goods, ie 'lumpy' expenditure. In these cases, other enforcement systems must be found. Such loan schemes are likely to be administratively more expensive and possibly more cumbersome from the borrower-perspective. Loan schemes where staging is not used tend to operate better when a long-term relationship exists between lender and borrower. Such a relationship may be based on extensive training or long-standing social relationships. This condition could be met, for example, by graduates of vocational training schemes, wishing to borrow for setting up their own business, or members of credit unions.

7. Charges and interest rates

Charges and interest rates need to be set high enough to cover costs. Theoretically, most microlenders agree, yet few follow this general rule. Obviously, inefficient lenders could experience problems if they tried to charge interest rates reflecting their true cost level. However, there is no efficient market yet in Southern Africa for the provision of credit to the poor. Hence price determination depends on a variety of factors, including concepts of Œfairness' (Dichter, 1997). Redistributional objectives sometimes influence the level of interest rates, or the range of services offered. Although even large and supposedly successful institutions subsidise their interest rates, the paradigm on cost-recovery persists. Finally, it should be noted that several countries legislate interest rate levels, or usury laws set a maximum interest rate that is legally chargeable. Although financial liberalisation has removed such limits in most countries, they still exists in some others.

Charges, such as membership fees, can be used to hide interest rates. However, most microcredit programmes offer more than merely loans; typically, business advisory services are available free of charge, some schemes offer insurance or bonus payments, and some even more extensive support relating to social and economic issues (Fuglesang and Chandler, 1986; Von Pischke, 1991). Micro-lenders then claim that charges and high nominal interest rates contain payment for these non-credit services and are not usurious. In any case, the determination of the Œreal' interest rate, relating to the costs of credit only, is methodologically difficult. Also, microlenders may generate income from non-credit services, for example by selling business implements to their clientele. Some institutions have used such lines of business successfully to establish their viability.

8. Savings

Many microlenders require their clientele to accumulate savings both prior to borrowing, but also during borrowing. Savings can perform various functions: people who save are more prudent, so arguably they make more reliable borrowers; savings behaviour helps to determine their debt capacity; and savings can be used as 'collateral'. Thus, self-selection, screening, and enforcement may be aided by savings accumulation. However, savings requirements have disadvantages: they exclude potential borrowers, the slow the expansion of credit extension, and they seem to contradict the very logic of micro-lending.

One important question, fought over with vigour, is whether savings should be used to 'hide' real interest rates. Especially when savings are pledged as collateral, the difference of deposit and lending interest rates provide a 'money for jam' profit for the lender. There is a heated discussion whether such profits are a justified means for making micro-lending schemes viable.

Although many microlenders incorporate into their lending strategy a compulsory savings component, only few operate discretionary savings schemes. Such schemes can appear desirable as savings mobilisation and the development of full intermediaries are higher policy objectives than the formation of mere subsidised lenders. However, discretionary savings schemes are relatively expensive to run and may not be easily compatible with the demands on an efficient microlender.

Some microlenders use their clients' deposits as loan funds. Besides regulatory implications, this is an important factor for the viability of a microlender (Chaves and Gonzales-Vega, 1994). Some institutions claim that their savings scheme provides a low-cost source of funds for their lending operation. However, microlenders with substantial savings business tend to operate in densely settled parts of Asia, where low-cost educated labour is available for staffing branches or mobile savings collections. In Africa, micro-savings services are generally expensive to produce. Unless alternative funding is prohibitively expensive, it seems the economically preferable alternative to concentrate on lending. The costs of operating savings schemes, therefore, need to be justified within the context of savings policy, not microcredit.

9. Training

In many microcredit programmes, there is an intimate linkage between training and credit. The benefits of linking credit with training are many; from the perspective of microlenders the most important effects are self-selection and capacity building. While many people will want to borrow, fewer are prepared to undergo training in order to become eligible for credit. Those who are, evidence suggests, are those more determined to run their business, and to run it well. Further, most entrepreneurs are unaware of their skills deficiencies, and therefore they are unlikely to seek training voluntarily. When access to credit is conditional on undergoing training, many come to appreciate the value of training.

Training can be offered basically in two forms: there is vocational training to equip entrepreneurs with the technical skills needed for running a service or manufacturing enterprise, and there is business training to help entrepreneurs to cope with the managerial aspect of running their own enterprise. Technical skills training requires more generous funding and typically takes much longer. Business skills training can be fruitful on a very basic level, and is often urgently needed prior to set-up. In many cases, both types of training are offered jointly, and both lead to better self-selection and enhanced survival rates of new enterprises. From the lender's perspective, this has the benefit that more borrowers will succeed in their business plans, and more will be able and willing to repay their loans. However, there are obvious disadvantages: training is costly, and training will exclude some potential borrowers.

When working with poor people, it is unreasonable to expect that they will be able to pay for their training up-front. Hence, training requires an initial outlay from the lender or a separate donor. Where appropriate training programmes already exist, potential lenders may target their lending at its graduates. In this case, the advantage of access to selected and able borrowers can be enjoyed without associate costs undermining the viability of the microcredit scheme.

However, the problem of exclusion still arises. Even when training is offered without charge, some borrowers will not be able to afford the time. Those who do already have a business may feel that they cannot afford to be absent for long, others may have family commitments. Very poor people cannot afford to take a few days off, not even for training. In response, some lenders have organised very short training courses, some taking as little as two hours. The benefit of very short training will be much reduced, both in terms of self-selection effects and learning. But it may still pass on basic business knowledge, especially when concepts such as interest, capital, credit and repayment need some explanation.

10. Discipline - Peer Pressure and Incentives

For many participants in the debate, microcredit and group credit have became almost synonymous. Especially sustainability, high repayment rate, and outreach became associated with terms such as solidarity and peer pressure. This association is arguably attributable to the well-publicised successes of the Grameen Bank in Bangladesh (Hossein, 1988). However, international experience is more diverse; in fact, evidence suggests that sustainability and cost efficiency are more easily achieved without the so-called Œgroup methodology'.

Group lenders have extensive relationships with their clientele. Often, they offer advice and support that is quite unrelated to enterprise development. Social empowerment, even health matters, are often discussed, and sometimes social gatherings - parties - are part of their working procedures. Frequent meetings are an important part of group lending schemes: they are crucial to the transparency and information sharing on which joint liability depends. Meetings are usually fortnightly, with an attendance of around six borrower groups, usually around thirty borrowers, and are attended by a credit officer. The function of meetings, and other form of social interaction, in group credit schemes is not purely economic; while meetings are part of the credit operation, they also have a social role. Group credit schemes have, therefore, more functions than credit extension alone.

However, social interaction is time-consuming, both for borrowers and for credit officers. Therefore, group credit is expensive if borrowers value their time. Also, and maybe even more important, the time-consuming nature of interaction between borrowers and credit officers limits the number of borrowers who can be served by a credit officer. While it is often claimed that credit officers can supervise several hundred group members, experience in Southern Africa shows that 150 is a more realistic aim. Due to the group lending structure, this implies that per credit officer, only about 30 loans would be outstanding at any time. Hence, credit extension will be staff intensive and transaction costs accordingly high (Reinke, forthcoming).

Avoiding group structures will greatly reduce the costs associated with establishing and maintaining group networks. However, extending credit to individuals without collateral and without group pressure exposes the lender to greater vulnerability towards free-riding and opportunism. Therefore, sufficient safeguards need to be applied to aid the selection of appropriate candidates and to enforce they compliance with rules and obligations (Reinke, 1996).

Several credit schemes now exist that do lend to individuals with great success. The safeguards they apply range from training requirements to credit rationing; some require that borrowers pledge savings as security; others tap local knowledge by requesting 'character certificates' from local worthies who are compensated according to the performance of their flock.

Through various mechanisms, these rules create an incentive structure that penalises default, forced withdrawal, from the scheme. Several studies show that microlenders that apply such safeguards for lending to individuals extend credit more efficiently than group lenders, taking into account both administrative costs and defaults. Group credit, in summary, is arguably more appropriate in densely settled areas with high social stability and low wage costs; under these condition, meetings can be convened without long travels, groups can be expected to be long-living, and the time- intensive nature of lending would entail relatively lower costs. Credit schemes lending to individuals are better suited where efficient transfer mechanisms are available, and where non-credit services - community development - is less important.

11. Conclusion - the Nature of Microcredit

This paper has discussed a range of criteria through which lending technology is defined. This list was not comprehensive; important factors include the internal management of microcredit institutions, staff development and remuneration, access to funds and the relationship to mainstream financial markets.

However, the list I discussed leads to a clear distinction between various groups of microlenders: those who provide a business service in an infant industry situation, and thus focus on economic viability, and those who see themselves as a comprehensive development and empowerment agency, and thus emphasise social change. With appropriate arguments, both approaches can be justified. However, many donors and microlenders hold on to unreasonably optimistic hopes of being able to combine the best of business mindedness and charity and compassion. Therefore, donors as well as lenders evade some hard choices; this may explain why many microcredit schemes promise to deliver on conflicting objectives.

References:

Bhatt, V.V., 1989, Financial Innovation and Credit Market Development, World Bank Working Paper, Washington.

Chaves, R.A. and C. Gonzales-Vega, 1994,Principles of Regulation and Prudential Supervision and Their Relevance for Microenterprise Finance Organizations, in: M. Otero and E. Rhyne, The New World of Microenterprise Finance, London: Intermediate Technology Publications.

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Reinke, J., 1997, Developing Linkages between Micro-Lenders and Commercial Financial Institutions, conference paper for presentation at a workshop on Microfinance Institutions and the Banking Sector: Needs for Linkage and the Development of Joint Mechanisms, 1 July 1997, European Investment Bank, Luxembourg, organised by Appui au Developpement Autonome.

Reinke, J., 1998, How to Lend like Mad and Make a Profit: A Micro-Credit Paradigm versus the Start-Up Fund in South Africa, Journal of Development Studies, Vol. 34, No.3, (February).

Reinke, J., forthcoming, Does Solidarity Pay? The Case of the Small Enterprise Foundation, South Africa, Development and Change, 1998. World Bank, 1996, Sustainable Banking with the Poor: a worldwide inventory of microfinance institutions, Washington.

Von Pischke, J.D., 1991, Finance at the Frontier - Debt Capacity and the Role of Credit in the Private Economy, Washington: The World Bank.

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