Policy Briefing: Microfinance

Why is this a hot topic?

On 16th December, the Myanmar Times covered the introduction to the Pyithu Hluttaw of a new Microfinance Bill. The Bill was originally posted to the Pyidaungsu Hluttaw website on 16th October 2019, and The Ananda published a Bill Summary, Backgrounder and Bill Analysis.

Since then, a number of media outlets in Myanmar have picked up on the new Bill and looked into the issues surrounding microfinance. In particular, Myanmar Now published this excellent article entitled Helping or hurting: Touted as answer to poverty, microloans trap many in debt.

What is microfinance?

As the name suggests, microfinance refers to small (micro) loans (finance). It is most strongly associated with rural development due to the seasonal nature of agriculture and the importance of credit for farmers, where finance is used for:

• seasonal production inputs (eg seeds, fertilisers, etc)
• long-term investments (eg purchase of new land, machinery, etc)
• regular consumption needs (food, clothing, rent, etc) – especially in the lean period before the annual harvest
• unplanned consumption needs (medical expenses, funerals, etc)
• meeting other outstanding debts

In addition to farmers, small businesses also benefit from loans as working capital, or to invest in scaling up their operations. Some international development agencies provide microfinance to enable economically excluded groups who may not ordinarily have access to credit, such as women’s groups, to develop their businesses and get their products to market (see boxed text on Grameen model below).

Traditionally, commercial banks have been reluctant to lend money to the rural poor or smallholders. They have tended to view them as unreliable borrowers due to their small and uncertain incomes and are discouraged by the risks and costs of providing services to rural areas where populations are thinly spread and infrastructure is poor; where the sums of money involved in individual borrowing and lending transactions are likely to be small; where incomes are unpredictable, due their linkages with agriculture, and; where people are usually unable to provide collateral (Stockbridge & Dorward, 2017).

Microfinance may be provided by:

• NGO Microfinance services/funds – administered by local, national or international NGOs, often with some financial support from governments or public and private sector donors.
• Credit unions and co-operatives, which vary enormously in size, but often have some sort of legal status conveying benefits in terms of tax concessions as well as obligations with regards to profits and what can be done with them.
• Small autonomous self-help groups set up by users themselves or with help from NGOs. They are typically informal.
• Commercial microfinance banks. This is a fast-growing area driven by the profitability of extending traditional banking services to reach a wider range of clients, aided by improvements in technology, such as mobile phones as well as rising incomes amongst the poor.

Whilst the early emphasis, from the 1970s, was on subsidised microfinance (ie donors would fund microfinancing to keep the interest rates low), more recently there has been a shift, driven by multilateral institutions such as the World Bank away from focusing on finance for the very poor but instead on how financial services can be made available for all (World Bank, 2008). This is on the basis that subsidies may spoil the credit culture – the willingness to repay loans since they are perceived as grants. They argue that shifting the focus to building inclusive financial systems and improving access for all underserved groups is likely to have greater impact on development outcomes. As a result, the development community has shifted its attention to also providing an array of other financial institutions, such as postal savings banks, consumer credit institutions, and, most important, the banking system. This broader approach can lead to overall financial system efficiency and outreach to the whole population.

The Grameen Bank model 

Microfinance as a concept epitomised by the Grameen Bank and the efforts of its founder Professor Muhammad Yunus to provide poor women in Bangladesh with access to small loans. Subsequent microfinance interventions have drawn heavily on the example set by the Grameen Bank, which has been highly successful both in terms of reaching the poor, proving that with appropriate arrangements the poor can borrow responsibly and be relied upon to repay their loans. Key features include the following: 

* no collateral is needed to obtain a loan
* repayments are made in regular and closely-spaced instalments to provide confidence to the lender
* group lending – this can take different forms, but the underlying principle is that holding a group accountable for a loan makes loan repayments more likely
* interest rates need to be affordable, but also high enough to cover a significant proportion of costs, and to sustain or expand the fund that is available to borrowers. Financial sustainability is very important
* women are often targeted, as they are seen as having the greatest need and as being more reliable when it comes to repayment
* credit for microenterprise is emphasised – often small-scale retailing or food processing, or self-employed cottage industries carried out in the home. 

The above list characterises elements of the microfinance model typically administered by NGOs or similar organisations whose mission is focused primarily on the social goals of improving the livelihoods of the poor rather than on profits, as is the case with the growing number of commercially orientated microfinance banks. 

Supporters of the Grameen model claim that a move towards a more commercially orientated approach will further marginalise the poor. Indeed, evidence does suggest that the clients of commercially orientated microfinance banks are less poor and less likely to be women than the clients of the more traditional forms of microfinance. In other words, the poorest of the poor are less likely to be direct beneficiaries of commercial microfinance, even if they may benefit less directly in the longer term. (Stockbridge & Dorward, 2017)

What are the benefits, and who are the beneficiaries?

At the national, macroeconomic level, improving access to credit has been a key ingredient of agricultural revolutions in various countries that have achieved sustained economic growth. South Korea, Taiwan, Japan and China – all have achieved high sustained growth in their post-war or post-colonial histories. (Studwell, 2013)

In the successful cases, access to finance reforms followed on the heels of significant land reforms, that redistributed land to smallholders and gave them security of tenure. Improved productivity was achieved through labour intensive farming that also created jobs, increased incomes, and therefore created a domestic consumer market to enjoy the new products on offer as industrialisation took place. Overall, then, improving credit markets is an important part of any national development strategy.

More specifically, the rural poor can be significant beneficiaries of microfinance schemes. Poor farmers in developing countries do not have access to sophisticated insurance products, which is why credit is especially important to help see them through bad years (although bad years may also often lead to difficulties in credit repayment). Because the rural poor often rely on casual labour or farming, their income is often erratic and unpredictable. Financial services are therefore especially important for the poor to help them even out the cash flows needed to meet regular consumption needs – ie for ‘consumption smoothing’ (Stockbridge & Dorward, 2017).

What are the risks?

Instead of widening finance and accompanying land reform some countries, notably Malaysia, Indonesia, Thailand and Brazil, instead sought to industrialise agriculture by acquiring land from the rural poor and creating large farms owned by big business interests. They were successful in achieving rapid economic growth for a period, but in these cases growing inequality has weakened their performance in the longer term, especially in the face of global economic instability. In the case of Brazil this led to economic collapse after the global recession of 2008, and in the case of Malaysia and Indonesia has lead to widespread environmental harm from deforestation for palm oil and other cash crops (Studwell, 2013).

There is a major risk in expanding access to credit without also supporting people and with advice, guidance and education on how to manage loans to avoid serious indebtedness. Formalising markets can help with these risks to some extent.

However, the tendency to only focus on loans is also a risk. Other financial products are also very important. For example, savings facilities can play an important role in the financial management strategies of the poor, reducing the need for credit and discouraging excessive spending at those times of the year when cash inflows are relatively high. Many of the rural poor depend upon remittances from relatives living in urban areas or abroad. Mechanisms for transferring funds safely can also be of great value to the poor, reducing the risk of money being lost or stolen and reducing the costs of physically transporting cash around.

Perhaps the greatest risk of expanding microfinance in a country like Myanmar is the land of accompanying reforms to land. This is because in order to access a loan, borrowers must provide collateral. Collateral is some asset that a lender gains a claim over as a security for repayment of a loan. In the event of loan default by the borrower, the lender takes ownership and possession of the asset. Collateral shifts the loan risks faced by the lender to the borrower.

In places where private property rights over land are well developed, land commonly serves as collateral. Its effectiveness depends both on the existence of land titles and the ease with which their transfer can be legally enforced in the event of a loan default. The rural poor usually have very little property that they can offer as collateral and in many parts of the world land titles are poorly defined and the legal enforcement of secured loans is problematic. Expanding microfinance in an environment where land tenure is insecure is irresponsible and will ultimately lead to many losing their land through loan defaults.

Also, in many developing countries the absence of functioning land markets limits the availability of suitable collateral for borrowing. This means that lenders have to demand a higher interest than they would otherwise. This, however, increases default risk. This is bad for lenders and would suggest a need for yet higher interest rates – but this would be self-defeating, fuelling a vicious circle of raised interest rates and raised default rates.

Recommendations for policy-makers

• Listen to stakeholders, especially farmers and rural communities, not just bankers and financiers. If a microfinance law is designed from the perspective of the banking/finance community it will serve their interest, and not the national interest or the interests of smallholder farmers in greatest need of finance. It is concerning that the forthcoming microfinance bill is being looked at only by the Banking and Financial Development Committee in Pyithu Hluttaw and not by Agriculture, Livestock Breeding and Rural Development Committee (Ananda, 2019). Such new laws and associated policies must be properly considered by parliament as representatives of many of those communities most affected by predatory lenders and/or land confiscation.
• Implement urgently needed land reform measures through an inclusive land policy development process. Land and credit are inextricably linked in rural economies, with land providing collateral for loans and loans providing seasonal inputs to make the land more profitable. Widening credit access without land reform will concentrate wealth in the hands of powerful business interests whilst risking increased dispossession of people from their family lands.
• Consider regulating for alternatives to requiring land as collateral to secure loans. A relatively recent innovation that is gaining appeal in some places is inventory credit based upon warehouse receipts. In these schemes, farmers can raise finance using crops deposited in warehouses as collateral. One of the purposes of these is to stop farmers being forced to sell all their crops at harvest time (when prices are usually at their lowest) in order to raise cash to pay off existing input loans or meet other financial commitments (Strockbridge & Dorward, 2017).