About 40% of the African population still lives under the poverty line. (2) Unfortunately, the rate of poverty reduction has not kept up with economic growth in Africa. The majority of people living in poverty are unemployed and unbanked, and therefore do not have access to formalised credit lines. Microfinance is an opportunity to provide a wider access to financial services to the neediest on the continent to enable them to become productive and earn a living for themselves. Microfinance is vital as banks have not historically provided financial services to low income individuals and households. Microfinance institutions (MFIs) typically deal with a large number of small value loans, whereas banks deal with a smaller number of loans, which have higher profit margins per loan. Banks have therefore, for a long time, rejected providing a service for this market due to the risk and low profitability of lending to clients who normally have little or no collateral or income.
This CAI paper discusses how MFIs are an opportunity to increase financial inclusion on the African continent and introduce more economic agents as Africa continues to grow. The costs and benefits of microfinance are discussed, as is the growing influence and importance of mobile technology in reaching a wider client base. This paper hopes to show that investment in microfinance by both government and the private sector is worthwhile both for business and the end users.
What is microfinance?
The main service generally associated with microfinance is microcredit. It consists in providing small value loans to individuals who normally have little or no cash or income, as well as small and medium-sized enterprises (SMEs). Microfinance has however evolved, and now includes a broader range of products including savings, money transfers and insurance. Banks were historically unwilling to provide these services to the poor. Credit and other banking services were reserved for people who already had an income, excluding the poor from accessing banking and financial services. Microcredit is mainly used in order to smooth consumption, start or develop a business, and for emergencies. The various types of microfinance providers include nonbank financial intermediaries (NBFIs), non-governmental organisations (NGOs), credit unions, financial cooperatives and banks. (3)
The main benefit of microfinance is to foster financial inclusion, so that working age adults have access to financial services whether for personal use or to fund business ventures. Microfinance addresses the deprivation of goods and services, thereby lifting the living standards of households, and, in the long run, communities. For both individuals and businesses, regulated microfinance also provides a more cost-effective financing solution in comparison to what may be offered by unregulated credit providers such as loan sharks, whose activities are more likely to weaken and jeopardise households’ financial situation. The flexibility that comes with microfinance is beneficial to households and businesses in times of emergency, especially in situations where there are few indivisible assets. Microfinance helps its clients to borrow small amounts and repay them according to their ability, rather than selling their assets, often in desperation, at an undervalued price. (4)
Microfinance initially starts out as a credit agreement, but clients are also offered savings products which are a useful source of financing for any future emergency, consumption or investment needs. (5) MFIs teach clients to save, and often require it of their clients. Savings serve as insurance to families and businesses, which would otherwise not have any back-up plan in case of an emergency. By being introduced to saving, clients have access to capital as and when need arises, also reducing the cost of future borrowing due to lower borrowed amounts and interest rates.
The two main reasons why MFIs serve small enterprises are that it helps them to grow their businesses and it allows them to follow their micro-clients as they themselves expand. (6) It may help small enterprises move from the informal to the formal economy improving the prospects of the enterprise owners as well as the community which may benefit from a wider range of goods and services. It may also result in increased employment and tax revenue for local and national government. Prohibitive taxation on these SMEs can, however, slow down or prevent the move to the formal sector.
While most benefits of microfinance are advantageous to the end user, providers also stand to make substantial gains. Large scale successful operations can bring good returns. As with many other areas of an economy, private organisations are likely to help improve the quality of microfinance services provided, while reducing costs, which would in turn benefit the consumer. Initiatives should be robustly tested before being rolled out on a large scale to ensure a higher rate of success for potential service providers. Given, however, that the aim of microfinance is financial inclusion, regulators should step in to ensure that borrowers that may be perceived as too risky are not left out by private organisations. This can create room for a two-tier system of service provision where the riskier clientele receive services from externally funded programmes that are able to absorb losses, but whose main aim is to ensure the poor are not excluded from financial services. Commercial operations would then take on less risky clients, and be reasonably more sure of getting returns.
Costs of microfinance
As with mainstream financial service providers, there are numerous costs associated with microfinance provision. These are mainly borne by the providers. Given that microfinance clientele usually have little or no collateral, interest rates are much lower than unregulated providers but higher than those available to the people and businesses that qualify for traditional bank loans. In working out interest rates, MFIs take into account the cost of obtaining the money it lends out, and the cost of defaults (so that these are covered by people who do repay loans). This is essential for the sustainability of MFIs; increased compliance and a reduction in defaults over time would allow for a reduction of interest rates which could then be passed on to consumers. To overcome the cost of defaults, some MFIs have tried group accountability (this is where the group is collectively liable for individual defaults). While this has worked in some communities, it should not be applied indiscriminately by all MFIs, as some communities have simply been unwilling to respect the liability on the group when they default, but are more likely to repay if they are only individually accountable. In-depth research would be needed to find a method that best suits a community. The final cost associated with offering microfinance services is transaction cost. It includes costs associated with appraising eligibility for the loan, processing, disbursing, repayment and follow up if need be. Transaction costs are typically consistent regardless of the size of the loan, and technological advances like mobile technology have helped to decrease these costs where some components of service delivery can be centralised. (7)
If MFIs do not take the initiative of teaching their clients to save and borrow responsibly, this could lead to the clients falling into debt traps, and not reaping the full benefits of having access to credit. Clients may be tempted to borrow from several MFIs, and then lack the ability to service all the loans without borrowing further, to cover initial loans. While repeat business from the same clients seeking further credit is often considered a success for MFIs, this should be monitored to ensure borrowers are indeed benefitting and not trapped in a cycle of debt. While mobile technology reduces many overheads in granting credit, face to face contact should not be eliminated altogether to ensure monitoring of clients’ affairs before granting more
credit. The cost of monitoring may reduce the gains of mobile technology but it is essential to ensure responsible and sustainable lending.
Role of mobile technology
A key opportunity for the development of microfinance rests in the use of mobile technology. With a continental mobile penetration of 65% in 2011 and forecasts to reach 85% by 2015, an opportunity exists for greater and faster growth of the microfinance industry. (8) Reaching the unbanked and providing financial services to the poor would only be a text message away. Mobile banking offers convenience, security and speed in the delivery and consolidation of provision of financial services. It also cuts the costs of having to employ people to offer these services and reaches a wider range of people, particularly in far flung areas. Mobile technology would, however, not be a solution for every market and may need in some instances to be used in conjunction with face to face service in order to provide the best outcomes for both service providers and recipients.
The monopolistic nature of mobile service providers in Africa could nevertheless be a hindrance to the widespread adoption of efficient mobile technology. There is normally very little competition between providers, which usually results in high costs for the end user. Cooperation with mobile service providers is therefore required to ensure that the organisations which are willing and able to make use of mobile platforms are not priced out by mobile operators which would offer an exclusive service which may not be the most efficient.
Operation and regulation of microfinance institutions
To be successful, MFIs need to ensure that they follow some basic principles and learn lessons from the past. Success or failures must, however, not be summarily dismissed or accepted as different approaches work for different regions. It is vital that MFIs adapt local knowledge and do not drastically change systems already in place unless they have proved to be unsuccessful. MFIs normally operate in areas where there has already been a level of informal access to finance. Building on what has previously been successful would ensure success, but this must not replace or undermine robust research to ensure viability. (9)
With the emergence of MFIs in Africa, many African governments have, in recent years, been formulating and adapting regulations to monitor and supervise MFIs. As MFIs become more commercialised, regulation is needed to protect end users. Regulators need to balance consumer protection with financial stability, access and integrity. (10) The distinct difference between MFIs and banks should be accounted for in the regulation to ensure that laws are supportive of MFIs. As such, it would be beneficial for licensing to be tailored to the specific needs of MFIs and the communities they serve as generic licensing may not capture all possible services that could be offered by different MFIs.
While it would be beneficial to impose a limit on the currency amount of each unsecured loan provided, regulators should not impose a percentage limit on the amount of unsecured loans given out by an MFI as is normally done with bank regulation. While this is no doubt risky, it is needed for increased financial inclusion. Instead of collateral, rigorous profiling of potential clients could be conducted to assess the lending risk. It could follow, then, that a single man would not easily get a loan, whereas the application of a single mother, well known within the community, would be approved. Limiting unsecured loans would exclude many people whom MFIs are meant to benefit. In the same vein, interest rate caps should be applied to ensure end users are not unnecessarily being charged high interest rates which may discourage them from accessing credit. Documentation requirements should be less stringent for MFIs, as clients will not normally be able to provide proof of income, or other such requirements a bank loan would need. This would simplify and quicken the process of loan appraisal and disbursement. Reporting to the regulator would be beneficial to provide an overview of trends in the MFI sector of a country. It must be taken into account, though, that this may increase overheads, and simplified periodic reporting may be more feasible than the daily reporting often required of banks. (11)
How to make it work for Africa?
Although microfinance is not necessarily a new concept in Africa, its commercialisation and formalisation have picked up in recent years. Where communities may previously have had informal access to finance, they are now able to take advantage of numerous microfinance initiatives. Mobile Venture Kenya (MVK) started an experimental microfinance initiative called Jipange KuSave (JSK) in a bid to see how microfinance can work in Kenya. Loans were provided to individuals through a mobile account, and clients would immediately qualify for larger loans after servicing an outstanding loan. The programme was successful in its pilot stage, and was deemed viable on a large scale. The only hindrance to the implementation of the project on a wide scale was the absence of robust regulatory laws that would allow the MFI to function. (12) African countries should therefore prioritise formulating MFI regulations to ensure that services are rolled out to the needy, and to ensure they do not miss out on opportunities to better themselves. In Zimbabwe, a company called MicroKing has recently sourced US$ 8 million to offer microfinance services, making it the largest MFI in the country. Although this is a welcome development, loans are specifically targeted at medium to higher levels of informal sector participants, (13) still excluding the poorest and neediest people.
Given that the African continent is made up of 54 diverse nations, there is no universal way of providing microfinance services to the whole continent. What is needed is to abide by general guidelines for regulation and supervision for MFIs to ensure that these institutions are sustainable. It would also allow end users to reap benefits which could help them to improve their standard of living and achieve poverty eradication. Any microfinance initiative should start on a small scale, with a gradual increase after viability is ascertained to ensure positive results for both providers and consumers. Microfinance represents an opportunity of mutual benefit for service providers and end users alike.
Written by Tapiwa Mhute (1)
(1) Contact Tapiwa Mhute through Consultancy Africa Intelligence’s Finance and Economy Unit ( firstname.lastname@example.org). This CAI discussion paper was developed with the assistance of Gaylor Montmasson-Clai rand was edited by Nicky Berg.
(2) Ncube, M. ‘Poverty is on the retreat in Africa’, African Development Bank Group, 26 March 2012, http://www.afdb.org.
(3) Chisten, R.P. et al. ‘A guide to regulation and supervision of microfinance’, Consultative Group to Assist the Poor, 2012, http://www.cgap.org.
(4) ‘Microfinance in Africa: Combining the best practices of traditional and modern microfinance approaches towards poverty eradication’, United Nations, 2012, http://www.un.org.
(5) ‘Microfinance in Africa’, United Nations, 2012, http://www.un.org.
(6) ‘Role of MFIs in serving small enterprises’, Consultative Group to Assist the Poor, 2012, http://www.cgap.org.
(7) ‘About Microfinance’, Kiva, 2012, http://www.kiva.org.
(8) Biosca, M. ‘Opportunities in Africa and Middle East’, A.T. Kearney Telecom Practice, 28 February 2012, http://www.gsma.com.
(9) ‘Microfinance in Africa’, United Nations, 2012, http://www.un.org.
(10) Chisten, R.P. et al. ‘A guide to regulation and supervision of Microfinance’, Consultative Group to Assist the Poor, 2012, http://www.cgap.org.
(12) Rotman, S. Ferrand, D. and Rasmussen, S. ‘The Jipange KuSave experiment in Kenya’, Consultative Group to Assist the Poor, 2012, http://www.cgap.org.
(13) Mhlanga, P. ‘MicroKing signs US$ 8 million deal’, The Financial Gazette, 10 October 2012, http://www.financialgazette.co.zw.
Edited by: Consultancy Africa Intelligence CAI
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