The Macro on Micro(finance): Part 1
Microfinance is a complex humanitarian intervention. It is also a sector that is experiencing great change. Mark Daniels, Opportunity International Australia’s Asia Programs Director, takes a broad look at microfinance to reveal its fundamental philosophy, how it assists those living in poverty, and the intricate challenges that lie ahead.
PART 1
Q: WHY WOULD SOMEONE LIVING IN POVERTY WANT TO GET A LOAN AND GO INTO DEBT?
MARK DANIELS: Like anyone, low income earners still require capital to set up and sustain even a tiny business. Once established, credit can then be used to help them create a more stable financial base for their business, and even expand that business so they can earn more. That process will help them improve their lives by providing the freedom to make economic choices as they negotiate their way out of poverty.
Meet Manda and her thriving sewing business >>
Q: WHAT DOES A PERSON LIVING IN POVERTY LOOK FOR WHEN CHOOSING A MICROFINANCE INSTITUTION (MFI)?
MD: People living in poverty deserve products and services that enable them to navigate and manage very complex cash management scenarios.
Thankfully, microfinance has evolved from a supply-led singular product environment to one that is demand-led that puts the client first. In the early days, most MFI’s had a ‘one product fits all’ methodology, e.g. a six-month loan term with weekly repayments. Too bad if you were a farmer and your harvest season was, say, four months away – you still had to make weekly repayments starting one week after the loan disbursement. Clearly that type of loan process failed the farmer. Modern lending practices now involve grace periods, top up loans, emergency loans and in the case of agricultural loans, bullet – or lump sum – repayments after the harvest.
Through our MFI partners, Opportunity also provides non-financial services including training and capacity building programs to help people improve and grow their business. Ultimately the aim is to help our clients buy better, sell better and run better. This can transform their businesses to provide better services to their community and contribute to the growth of their local economy.
"In the early days, most MFI's had a 'one product fits all' methodology..."
Q: WHAT ARE SOME OF THE BEHAVIOURAL PRACTICES YOU’VE SEEN WITH PEOPLE REQUIRING LOANS?
MD: When you study the behavioural economics of people living in poverty you quickly understand the ‘need for speed’. We always hear people in poverty live on two dollars a day; that’s nice but they don’t literally get that amount each day. Being poor means you are constantly juggling cash flow and having to manage irregular and uncertain incomes and the daily challenge of feeding hungry children, basic consumption needs, education expenses, purchasing emergency medical supplies, not to mention family or friends who are in immediate need banging on your door for cash.
To be honest, people in poverty are the best cash flow managers in the world! Studies show that on average, someone living in poverty will have up to eight different sources of credit and savings to help manage their poverty, and in many cases can lead to ‘multiple borrowing’ as they balance day-to-day responsibilities. I have observed that it is extremely difficult for the poor to ‘budget their way out of poverty’.
"We always hear people in poverty live on two dollars a day; that’s nice but they don’t literally get that amount each day."
Q: TELL US MORE ABOUT MULTIPLE BORROWING?
MD: Multiple borrowing—or ‘credit pollution’ as it is sometimes referred to—is when a client is forced to borrow from several institutions in order to meet their capital/consumption needs. In many cases MFI’s lending methodologies are quite rigid so a client is required to complete a loan cycle on a small loan without default before they can be approved for a larger loan. This is one reason why repayment rates are quite high for MFI’s as loan sizes are small and clients are desperate to access larger loan sizes in following loan cycles as borrowing from microfinance institutions is often the most reliable source of funds.
But in many cases people in poverty are simply forced to borrow from multiple institutions to meet their immediate needs. It is no different to credit card debt where one card is used to pay off another. The same occurs with multiple borrowing where those in poverty ultimately borrow from one institution to pay off another and the cycle of indebtedness becomes entrenched. This is why good product design is critical for MFI’s to help clients reduce the friction in financial lives.
Q: TO MEET THOSE NEEDS, PEOPLE OFTEN BORROW FROM INFORMAL LENDERS KNOWN AS 5/6 LENDERS. WHAT ARE THEY AND WHY DO PEOPLE FEEL COMPELLED TO USE THEM?
MD: A 5/6 lender is an individual informal money lender. They are colloquially called ‘Mumbai’s’ given the practice of money lending in India. The basic premise is that they will lend you five dollars in the morning and you will have to repay six dollars in the evening – so an approximate 20 per cent interest rate per day or annual percentage rate (APR) of more than 1,000 per cent.
With no cash in reserve, accessing funds quickly can literally be life and death for somebody living in poverty. Speed is everything to a client with a sick child, for example, so if an MFI is unable to lend emergency loans or enable immediate access to a person’s savings, a person in poverty will have to hunt down an alternative. This is why informal lenders provide an important service to the poor with short term daily, no documentation, loans.
“…if an MFI is unable to lend emergency loans or enable immediate access to savings, a poor client will have to hunt down an alternative.”
But there are significant dangers attached. If the borrower is unable to pay back the loan on time, the consequences can be dire, and in some cases even sexual favours can be procured by the ‘Mumbai’. Tragically, I once heard the case of a microfinance client who was unable to urgently access her savings from an MFI so was forced to have unprotected sex to get access to immediate cash through an informal lender, to pay for school fees. Horrible examples like that really show the need for speed in loan disbursement and voluntary access to savings from microfinance institutions.
Speed in loan disbursement is also one reason why mobile financial services and fintechs (financial technology and innovation methods) are now available in the market to provide fast and 24/7 cash solutions.
Q: WHAT IS THE BEST WAY AROUND THIS?
MD: Good product design based on better analysis will drive appropriate cash flow-based lending. In many cases the loan recipient will actually have the ability to repay the larger loan sizes to meet their working capital requirements but be forced to take smaller loans.
Borrowing the right amount from one lender will alleviate multiple borrowing and the dangers that go with it. So, the most important department within an MFI is the research and development team as they seek to understand and listen to customer insights and then adapt the product design features to meet life cycle needs.