“Microfinance organizations are mostly known for disbursing loans at very high interest rates.” These words opened an article describing the November 2012 Russian microfinance annual conference. The young journalists who wrote this may not have been previously exposed to the topic. Yet by describing MFIs in this way, they unwittingly laid bare one of the most critical issues in microfinance today in Eastern Europe and Central Asia (ECA): a deep and growing divide between commercial, high-interest consumer finance and traditional social purpose microlending, and the confusion of the two in the eyes of the public. We feared this last year as we published our thoughts about the development of the sector in the region, and unfortunately, our prediction is coming true.
All over the ECA region, microfinance emerged some two decades ago as a socially-oriented development movement aimed particularly at helping vulnerable, low-income population segments with the transition to a market economy. Though in some ECA countries (including Russia), financial cooperatives rose up providing both small balance savings and small loans, the emphasis of the early microfinance institutions (MFIs) in the region was typically on microloans.
Initially small and largely unnoticed within financial markets (and known only to its stakeholders), microfinance has grown to become an important and integral part of many ECA countries’ financial systems, with sustainable – indeed profitable – MFIs in most countries in the region. For example, in Mongolia, MFIs are currently providing loans to over 13 percent of the total population; in Kyrgyzstan and Tajikistan, special legislation was adopted a decade ago to allow mobilization of deposits by licensed MFIs; and in Bosnia and Herzegovina, Georgia and Russia, there are MFIs that have transformed into specialized banks.
In most markets in ECA, MFIs have generally survived the recent economic and financial crisis, even though the region has been hit by it the hardest of any worldwide. Microfinance has come to be defined by regulation in most countries in ECA, and it is now a concept widely known to policy makers and the general public. How ironic that at the peak of its recognition, in Russia, Bosnia Herzegovina, and some other ECA markets the term ‘microfinance’ should become associated with things never intended by its original pioneers. Now that one can find under its umbrella (as understood by local media and the general public) a multitude of aggressive consumer lenders – often charging interest rates many multiples of that charged by sustainable socially oriented MFIs – it is not too surprising that the term ‘microfinance’ should be gaining a muddied, but generally negative connotation.
Why has this happened in ECA? First of all, in most countries where there is a regulatory definition of ‘microfinance’ or ‘microlending,’ loan size is the key (and sometimes the only) determinant of what the law recognizes as ‘microlending’ activity. Secondly, under the regulatory frameworks of many countries in the region, microfinance constitutes the only available regulatory option for operating a non-bank lending business. It should therefore have been expected that a rich soup of variously motivated non-bank lenders would establish themselves as MFIs – as has already happened in Russia and is happening now in several other countries in the region.
From a regulatory and supervisory perspective, we certainly know that is it not just the loan amount that differentiates what might be termed ‘traditional’ microlending. As observed in the recently issued second edition of CGAP’s Guide to Regulation and Supervision of Microfinance , traditional microlending is characterized by a methodology used by successful MFIs to manage the operational and credit risk of making large volumes of small uncollateralized or undercollateralized loans – a methodology that typically includes such elements as the lender’s personal contact with the borrower, an analysis of the borrower’s cash flow as opposed to scoring, various incentives rewarding strong credit discipline of the borrower etc. Beyond these common methodological features, ’traditional’ microfinance meant to the initial pioneering MFIs in the ECA region a commitment to servicing to low-income client segments, typically for business purposes, but invariably with a concrete goal of improving their well-being.
We hope that 2013 will see a rethinking of the term ‘microfinance’ as it is currently legally defined in many countries in ECA, and the emergence of more nuanced regulatory approaches capable of differentiating among different types of small-value retail lender. ECA’s socially-oriented microlenders (many of whom have joined the Smart Campaign) – thereby committing to minimum standards for considering client well-being) should not have to share their name and regulatory status with every manner of nonbanking lending institution – including some whose business model and practices involve no consideration of client well-being whatsoever.
--- Olga Tomilova is CGAP’s Regional Representative for Europe and Central Asia. Tim Lyman leads CGAP’s Government and Policy Team and is its Regional Manager for the ECA region.
Although I agree with the conclusion that socially-oriented lenders should be under their own label, this would be very difficult to implement because who would evaluate and categorize institutions? If the government outlined minimum requirements or defined "socially-oriented" and even if the general public became aware of this, lenders could lie about their lending purpose if there was no enforcement or could cheat or bribe officials in order to qualify for the title.
Perhaps the free market will recognize this gap and a private institution will open that evaluates, ranks and publishes results to better inform consumers on which lenders are 'doing good' and which ones are agressive and lack sustainability. If the aim of starting MFIs in ECA was to help vulnerable and low-income groups in the transition to a market economy, then we can at least hope that the market will not fail them now.
The Pro-Poor Seal of Excellence has come into existence for precisely this purpose: to help identify and recognize those MFIs that are doing the most to reach people living in poverty. Working with a panel of industry experts, we have identified key indicators and soon will go live with our assessment methodology.
Our inaugural meeting of the Poverty-focused Microfinance Community of Practice occurs on Wednesday, 6th March.
Email us if you would like to participate, [email protected].
The issue is important and can be extended to other countries. Good social MFIs could define basic criterias to follow to be qualified as such and list themselves on a website. Additional "independant" stakeholders could be included in the selection committee. The next step would be to raise local awareness about the issue.
Mere harping over micro loan services cannot help sharpening the definition of Micro finance. Attention is drawn. to the definition of WB, CGAP,ADB, NABARD(India) referring micro savings. micro insurance, transfer services, of late micro pension etc besides micro credit as Micro finance. It seems that MFIs in ECA are only doing money lending services to the low income people like modern money lenders. Conceptually these MFIs deserve to be called as micro credit institutions(MCI) not as MFI literally.
Micro finance with package of pro poor financial services need to be encouraged with social orientation for challenging their vulnerability and deprivation for the poor segments rather than unethically confining to money lending services only calling as MFIs. In the process of sharpening the definition of MF it is imperative that the above hidden noble universal principles of micro finance need to be promoted globally for effective achievement of MDG.