Small and Beautiful

Better Business

October 2006

Banner photo: Partially Harvested Corn Field/corbis

By Grzegorz Galusek

Imagine life without a bank account, insurance or credit cards. It's hard to believe, but globally almost 3 billion low-income people live without access to formal financial services. In some developing countries this proportion can be as high as 90 percent of the total adult population, while it is estimated that in the so-called developed countries of the West, financial exclusion may affect 10 percent of people.

The lack of access to financial services represents a major obstacle to improving the socioeconomic choices of the poor. Access to financial services enables low-income people to increase income and smooth consumption flows, which is how their vulnerability to external shocks (such as sudden deaths of family members, illness, weddings) can be reduced. Moreover, for many of these people petty business is the only source of income and employment, so they also need small amounts of money to manage their trading, production or farming activities: to purchase supplies or to invest in tools, equipment or improved premises.

The Grameen Model

Over 30 years ago, Dr. Muhammad Yunus, a Bangladeshi economist, offered small loans to groups of village women producing bamboo furniture in Bangladesh, who for years had been financing their production with high interest rate loans from money lenders. The interest rate on such loans was so high that the price they received for their furniture barely covered their costs. With Dr. Yunus's loans the women quickly multiplied their income and paid off the loans. As of May 2006, the Grameen Bank--the first "bank for the poor" which Dr. Yunus founded--had 6.39 million borrowers, 96 percent of whom are women.

Microfinance customer Tifa Patkoviae and her cow

Dr. Yunus's idea of small, non-collateralized loans inspired experiments by NGOs to provide loans to impoverished entrepreneurs and eventually led to significant growth of institutions that offer financial services to low-income people on a sustainable basis. Such institutions are often referred to as "microfinance institutions," and they can be of different legal forms (NGOs, financial cooperatives or even banks). Typically microfinance institutions do not require collateral from their prospective borrowers. They focus their loan analysis on the clients' character, cash flow and commitment to repay the proposed loan.

A popular microfinance guarantee involves "joint liability" from members of 3-6 person groups, where each member receives a loan and is responsible for the repayment of the other group members.

The example of the Grameen Bank has been used in developed countries as well. For example, in France micro-loans were first offered in the 1980s at a time of high unemployment. ADIE, a nongovernmental microfinance institution, was created to encourage entrepreneurship among people without jobs by offering small loans to set up micro-businesses. The idea was revolutionary at the time, as it was common to think that beneficiaries of state support were not capable of creating their own businesses.

Today ADIE serves over 15,000 active low-income clients (most from immigrant families), helping them finance their business initiatives.

It's important to stress that microfinance is not about charity. On the contrary, it offers services for a price. Today the term "microfinance" includes many products: micro-loans, savings, micro-insurance or money-transfer products. The design of such products is based on market principles that reflect the preferences of low-income people.

Financial Cooperatives

Microfinance is also not new. In Europe, the Raiffeisen model of savings and loan cooperatives spread by the late 1800s as a response to severe poverty and to empower local communities to reinvest their savings in the local economy. Currently, financial coops in Ireland, Poland or Ukraine reach millions of members, the majority of whom are low-income people.

In Eastern Europe, the recent transition from centrally planned to market economies caused widespread unemployment and high levels of poverty. The restructuring and privatization process within the financial sector also resulted in a huge financing gap for fledging businesses. Microfinance institutions (MFIs) emerged in the early 1990s to meet these needs. They serve a wide range of clients: from clients with limited or no business experience, whom transition or war (for instance, in Bosnia and Herzegovina) left as a new category of poor and unemployed, to more established micro-enterprises employing 1-2 people, often family members, and larger micro-enterprises with 5-10 people.

By supporting such enterprises, MFIs are helping develop transition economies from the bottom up. Together, they serve, in a sustainable way, over 3 million clients. The current approach involves the creation of specialized banks that serve micro and small businesses. Seventeen such banks have been set up in the transition countries of Eastern Europe since 1997, serving over 600,000 micro-entrepreneurs.

Challenges Ahead

Poor people can pay for financial products, if only they get products that respond to their needs. This creates a great opportunity for other businesses that have so far been focusing on the higher end of the market.

As yet, however, MFIs serve only a fraction of the existing market. The challenge is to apply the existing knowledge on a much greater scale. Currently, many providers of microfinance services are exploring innovative delivery channels and multiple service points.

For instance, the insurance company AIG partnered with microfinance providers in Uganda to offer personal accident micro-insurance to more than 1.6 million low-income clients and their family members. This has caused competition from other insurers in Uganda and resulted in better products with more favorable pricing for the low-income market.

Global banks (such as Citigroup, HSBC or ABN AMRO) are moving into microfinance by striking partnerships with local microfinance institutions in many countries (Turkey, India, Mexico, etc.), all with the purpose of tapping into a huge unrealized market potential. Currently there are discussions about creating a secondary market for the microfinance loans. Such loans, if bundled together into larger bond issues, could be sold to investors globally. This could be a real breakthrough in financing expansion of microfinance services.

Countries all over the world are realizing the great potential of microfinance. Its significance goes well beyond the delivery of well-designed financial products: for the first time it creates opportunities for the majority of people.

FORA

The FORA Fund and FORUS Bank have over 17,000 clients in Russia.

Galina Ivanchenko is the leader of a six-member borrowers' group in Belgorod which has been working with FORA for over five years. Galina sells men's and women's footwear in the markets of Belgorod. It took seven years of hard toil for her business to succeed.

Galina's story is typical of her group members: cooperation with the Fund has changed the life of every borrower. FORA's loans increased their businesses' profitability and, as a result, their families' welfare. Their product range grew bigger and more outlets were rented. Today some entrepreneurs apply to the Fund for their 10th, some for their 20th loan. By buying in larger quantities, they can hold prices low, which attracts customers.

Other FORA clients include Dlavdia Azizova in Lipetsk. She took out her first loan of 25,000 R (around US$940) in 2002 when she had one outlet in a local market, a small amount of stock and no staff. After working with FORA for four years, she could expand her stock range, rent two cafs and repair them and set up a business catering for wedding parties. She now employs 16 people and is using her sixth loan of 250,000 R (US$9,400) over two years.