Financial inclusion is essential to building a just and stable future. Improving economic security increases access to food, health and education, and remains one of the most important tools to promote gender equality.
In my view, the COVID-19 experience has underlined the importance of comprehensive financial inclusion, even while testing our ability to deliver it. Restructured portfolios are proving difficult to collect, and institutional growth remains sluggish amid economic uncertainty.
The pandemic has stripped resilience and strained resources, pushing people into poverty and making inherently vulnerable institutions more insecure. Those with savings and access to capital have fared better; those with limited resources are faced with existential choices. Without significant and coordinated action from donors, social investors and regulators, responsible financial services to the unbanked in many vulnerable countries are at risk.
It is worth recalling that early on, microfinance proved its sustainability, becoming the golden child of development finance and attracting the attention of those who were tired of the endless cycle of aid. Collectively, the sector focused on demonstrating that it could grow and become more commercially viable.
More recently, a view has emerged that fintech can replace the labor-intensive microfinance model with one that is significantly cheaper and more scalable. While this is still an open debate, the idea has gained momentum as COVID-19 has upended the microfinance sector. The implication is that microfinance institutions should be allowed to fail to make way for fintech.
The problem with this approach is that even if fintech could eventually replace microfinance, it wouldn’t happen overnight. There are many reasons for this. For example, most individuals facing financial exclusion can’t yet effectively use mobile financial services. They lack reliable connectivity, the cost of usage is too high and the products available to them have limited application. Further, human intervention is often required to motivate change, whether related to financial inclusion or gender parity.
Until we have a reliable means for motivating responsible financial behavior through technology, the current microfinance model is irreplaceable. The people who depend on microfinance institutions for productive credit and other services can’t afford to see microfinance institutions vanish now and wait for fintechs to hopefully replace them someday. We can balance the best fintech has to offer with the realities of the microfinance customer’s needs.
This means that, yes, microfinance is worth saving. It doesn’t mean that every microfinance institution should be protected or needs the same level of support. But microfinance loans are often the only financial services available to the most vulnerable farmers and entrepreneurs. When these groups are cut off from financial services, they remain in or fall back into poverty.
We should remember that microfinance is a narrow slice of the broad spectrum of financial services providers. It serves the needs of clients who cannot access traditional financial services for a variety of reasons, among them distance, education, gender, assets, income and lack of credit history. The Findex provides us with ample evidence that these individuals live in difficult-to-serve locations: volatile political and economic environments with limited infrastructure and education.
And there is a wide variety of microfinance institutions. The large institutions are well capitalized and have the capacity to withstand shocks. They are sizeable enough to negotiate strong liquidity and can afford the costs of hedging. Their scale and profitability attract superior management and governance. They benefit from favorable regulation and government support.
Unfortunately, these institutions alone do not sufficiently meet the needs of all who need banking services, especially poor people. The microfinance institutions with the best long-term commercial prospects have achieved significant scale in one of two ways: by operating in large, typically urban markets with high population density, or by serving a broader, wealthier clientele (going “up-market”) while maintaining a social impact focus. They generally do not serve low-income clients in rural areas, who make up a large proportion of the world’s poor, because the profit margin is smaller or even non-existent.
Smaller, traditionally less stable microfinance institutions cover this gap. Many mirror their clients: they are small, high-margin businesses that are difficult to scale because their largely rural clientele is highly dispersed and complex to serve. Even under the best of circumstances, limited infrastructure, health and education challenges, and political instability make it hard to operate successfully. COVID-19 adds another layer to the challenge.
These institutions don’t have the resources, balance sheets or intention to go up-market. They need reliable sources of local currency funding. They also need strong long-term partners who are willing to risk their capital and who accept the fact that not all markets are equal. There is a cost to filling the access gap, and that gap is larger in economically and politically volatile markets.
While the COVID impact analysis by CGAP, MFR and Symbiotics gives reasons for hope that microfinance will rebound, it highlights the relative vulnerability of smaller institutions. It also underscores the uncertainty around recoverability of restructured portfolios. In many markets, smaller microfinance institutions are now wrestling with exactly these challenges: how to absorb the shock of non-repayment in an environment of dampened growth amid economic uncertainty.
This is not to say that all smaller institutions merit rescuing. Some markets may be oversaturated, and others may benefit from more efficient operations that better serve customer interests. In those cases, investors and donors should assist and drive consolidation to ensure clients who have been served over many years can thrive.
What is crucial, however, is that support accelerates for institutions with a proven track record of sustainably delivering social impact in places where there are not others who can immediately step in to serve those needs. This means both increased funding and regulatory relief that ameliorates the impact of COVID-19 on people on the edges of the economy and the institutions that serve them.
Fintech holds promise, but we mustn’t tear down the bridge before the destination is in sight. Poor entrepreneurs who need access to productive capital do not have the luxury of time to wait for future experiments. They need us to work together to support them through the pandemic and beyond.
Andrée Simon is president and CEO of FINCA Impact Finance. This is the second post in the CGAP blog series, "Microfinance Solvency and COVID-19," which looks at key issues related to microfinance providers' solvency amid COVID-19 and explores ways forward for the sector.