Assalamu'alaikum wr. wb.
A financial institution provides financial services such as saving accounts, mortagages, consumer credit, insurance, loans for funding a bussines ang money transfer. The practice of adding more financial services from the supply side, such as insurance, is a common trend among financial institutions worldwide and comes from the different and increasing needs of these kind of services by their clients. This trend is also helped by technological innovations that are reducing costs for almost all kinds of financial products, allowing more and more people to use them and the industry to meet every time in a better way the demand of their clients. Transferring money between different continents has become easy and fast, different kinds of insurances such as life, cattle or weather risk are widely available in industrialized countries. This is the situation in these countries but is it true also in developing countries? Can low income people access these financial services?
Products delivered by MFIs are many and include loans, savings, insurance and money transfer. Non financial products such as training or consulting are also often delivered by microfinance institutions. This session analyses the main features of these products. Loans, and increasingly savings, constitute the main products actually offered by MFIs but as the industry matures additional products have been intr duced by many institutions.
4.1 Loans
The success of many MFIs can be identified in their ability to combine successful practices from the informal sector (moneylenders) into formal institutions. These include flexibility, fast access to funds, clear and easy conditions. The extraordinary success of microcredit comes from its ability to replicate some of these features from moneylenders into more “formal” financial institutions lowering the interest rates applied. These interest rates still remain much higher compared to traditional banking loans due to the higher administrative costs of managing many small loans instead of fewer with larger amounts. However, what is important is to give access to credit to people who otherwise would be excluded from the formal financial system at interest
rates that are much lower compared to the interest applied by the competitors, that for this market segment are the moneylenders.
The specific features that microfinance institutions should implement to deliver valuable services for their clients are listed below. These characteristics are met quite well by moneylenders giving them a competitive advantage. But MFIs that have been able to include these features into their credit services successfully replicated this competitive advantage.
1. Fast access
Rapid loan approval and fast disbursement is crucial for clients and it is often the main reason why many people deal with moneylenders even at very high interest rates.
2. Clear, easy and flexible conditions
It is important to provide the credit service at convenient conditions for the clients. Transaction costs, which include transportation costs (to pay the instalments or get the money) or time away of work, throughout the life of the loan must be kept low. Loans should also not be strictly linked to a specific purpose. MFIs should monitor the income streams of their clients but with a certain level of tolerance as restricting the possible use of funds will not allow microentrepreneurs to have the necessary flexibility in the use of the money received and thus interfere with the microbusiness development.
3. Permanent services
Credit services must be provided on an ongoing basis, not only for a limited period of time. The lack of this requirement is the main shortfall of many projects that despite their effectiveness do not have the goal of delivering financial services on an ongoing and sustainable basis.
4. Alternative collaterals and collateral substitutes
Poor people often lack traditional collateral. To overcome this obstacle many MFIs use other kinds of collaterals known as collateral substitutes and alternative collaterals. Group guarantee is an example of the former, while personal property such as equipment or jewellery are an example of alternative collateral that are not accepted as collateral by the traditional banking sector.
4.2 Savings
MFIs typically offer two types of savings accounts: voluntary and forced. Voluntary savings replicate the savings services provided by traditional commercial banks while forced savings serve as collateral for the loan. These accounts do not necessarily provide a return on deposit and are kept by the institution until the balance of the loan has been paid off.
The “first generation” MFIs only provided credit to their clients in the belief that it was the only service they needed. This assumption has been demonstrated to be wrong and the most important additional financial services that the poor need are saving services. Loans for setting up a microenterprise are useful only to people that have economic opportunities and entrepreneurial skills while more people need to save instead of keeping riskier assets or hiding cash at home. Table 4.1 summarizes the principal forms of informal savings and their respective appropriate financial product. Informal savings shown in the table have the main disadvantages of the lack of security and they do not provide returns such as interests. However keeping gold, land or other assets may protect from periods of high inflation typical of many developing countries.
Liquid accounts are flexible saving products often with no or small minimum balance but they usually do not provide or pay very little interests. Time deposit accounts, on the other hand, usually offer higher interest rate but clients have to leave their money in the account for a specified period of time.
Table 4.1 Informal savings and correspondent financial instruments
Microfinance institutions should provide a complete set of short, medium and long term deposit accounts, in addition to more liquid accounts. This to meet the diverse needs of liquidity and rates of return of the clients.
Savings will also attract more clients than loans alone and constitute an important source of funds for the institution. Furthermore it should also be a less expensive source compared to traditional commercial loans as for most MFIs it does not represent a big additional cost. This is due to the already available infrastructure required to collect savings (branches, trained staff, clients relationships).
Box 4.1 ProCredit Network
If deposit services are successfully implemented, the provision of these kind of services will also help MFIs to reach financial sustainability. Introducing savings facilities will better serve the clients’ needs, reducing the cost of capital and allowingm MFIs to accumulate resources for expansion. The main challenge for MFIs in establishing these services is the transformation of their corporate culture and also the involvement of the governments is equally important in the regulation and supervision of institutions taking savings from the public. Mobilizing savings is generally forbidden to NGOs and all the other MFIs that do not hold a special license. It is needed for every kind of financial institution in order to protect savers in case of the institution’s default and is particularly important for poor people who cannot afford to lose their money. To address these problems and overcome the requirement of the special license many MFIs offer saving services not directly but in partnership with a licensed deposit-taking institution, typically a bank.
4.3 Microinsurance
Low-income entrepreneurs, just like anyone else, are vulnerable to risks, such as illness, injury, theft, death, accidents and flood. This is why financial products to mitigate the effects of these risks are valuable for them.
Insurance is a financial service that some MFIs are starting to add to their portfolio to respond to this need of protection. Providing savings and insurance services besides credit make the MFI a full service financial institution delivering microfinance, i.e. a full set of financial services to low income people.To directly provide insurance MFIs need a special license and the requirements to be granted such a license are usually very strict: governments control insurance companies for the same reasons why they control the financial soundness of deposit taking institutions, the protection of the clients and the stability of the system. As the majority of the MFI do not satisfy these conditions, there are alternatives to the directprovision of insurance and the most common is a partnership with an existing insurance company. Insurance companies may not offer their products directly to poor people because they lack experience in this market segment: the MFI can fill this gap and work as an intermediary between the insurance company and its clients. Insurance products to the target group of microfinance institutions must be designed to fit their specific needs and protect their specific risks: they may include health insurance, livestock insurance and crop insurance. At present few MFIs are offering insurance services but as the industry grows they start to be included among the set of products offered.
4.4 Money transfer
Money transfer service is another critical financial service: the business of remittances, i.e. the money that emigrants send home to relatives, is growing strongly and is often managed by informal arrangements with high charges and high risks. Depending on the local regulation and costs this service can be delivered directly or in partnership with money transfer companies. MFIs owns the competitive advantage of the relationship with their clients and such service can also be linked to other products or can be taken into account when calculating the repayment capacity of each client. There is the possibility to link remittances with credit products when remittances are not used for consumption but for production purposes, combining the different sources of funds. A study by Manuel Orozco showed that in 2002 the average fee to send between
US$150 and US$300 from the United States to Central America was on average 7.35 percent the value of the amount sent, to which must be added average additional costs of about 2.3 percent. The total average percentage paid on a transaction of US$150 was about 18 percent. These high charges are primarily due to a low competition in the market and this is why MFIs started to provide, together with the other traditional financial products, this valuable service for their clients.
