BY ALISON DECKER
Alison Decker is a second-year student in the international development program at SAIS and a senior editor at SAIS Perspectives.
The Development Roundtable hosted Andrée Simon, President and Chief Executive Officer of FINCA Impact Finance, to discuss the rise of microfinance and innovations within the field. With operations in 20 countries and a gross loan portfolio of more than 800 million USD, FINCA Impact Finance’s banks and microfinance institutions offer responsible and affordable loan and saving products to more than two million low income women and men across the world. Ms. Simon earned an undergraduate degree in international relations from the University of Virginia, an M.A. from The Johns Hopkins University School of Advanced International Studies, and an M.B.A. in finance from the University of Pennsylvania’s Wharton School.
Below, SAIS Perspectives highlights some key takeaways from the discussion.
Microfinance: the basics
The demand for microfinance rests on the assumption that everyone needs access to financial services. Around the globe, no matter one’s income, people have the same financial needs: to send their kids to school, to buy groceries, to pay for emergencies, or to save their income. But many people don’t have the tools to use their income the way that they want to, particularly in savings and loans. In order to generate cash, many poor people must sell their assets, liquidate their savings, or borrow money—which often comes from money lenders at exorbitant interest rates, sometimes reaching up to a 200% annual effective interest rate. Traditional banks have historically been reluctant to serve unbanked communities, who don’t have assets that can be used as collateral. Default risk is high, and transaction sizes are typically small. For banks, the costs of processing large and small loans are the same. And so for small transaction sizes, the administrative burden required to process the loan doesn’t seem worth the investment. The traditional banking model wasn’t working for the needs of poor (and often rural) communities. So, microfinance burst onto the scene.
The basic microfinance model was predicated on a group methodology: microfinance institutions bundled clients together and issued loans to the group as a whole. This model relied on the social fabric of the group to reduce risk and increased the overall capacity of the group to repay. Default risk was transferred from the bank to the group, and microfinance institutions were able to increase the loan sizes, reducing the administrative burden. These loans turned out to be quite successful. For a traditional bank in the United States, the default rate is roughly 12%. For clients in the FINCA Impact Finance portfolio, the default rate hovers around 3%. Low income communities were able to access the funds that they needed and had financial options available to them.
Improving microfinance access
Though the basic microfinance model was able to provide financial services to historically underserved communities, some complications emerged. The disbursement process was lengthy, often taking up to 22 days, as credit officers needed to travel to visit rural communities to evaluate the risks and determine the type of financial services that a microfinance institution would be able to offer. When surveyed, FINCA Impact Finance clients said that the biggest factor that prevented them from utilizing FINCA Impact Finance’s financial services was the slow speed of disbursement—more so even than potentially higher interest rates. In response, FINCA Impact Finance searched for innovations that would allow them to speed up the lengthy process, but still maintain low risks of default. Essentially, they sought to make decisions about credit by using new sources of data to predict credit outcomes. One innovation was to develop call centers: they gave their credit officers tablets, which could easily transfer information about potential clients to a central unit that could make credit decisions and disburse funds quickly. Even in locations where there is no national ID system or credit bureau, FINCA could then reduce its disbursement time from 22 days to one, sometimes making loans in minutes.
FINCA Impact Finance also built relationships with mobile network operators, who are primary users and collectors of data in developing countries. Though there may not be maps or demographic data for rural communities, there is information about their cell phone usage. FINCA Impact Finance was able to get data to verify their customers, and by using cell phone bills, FINCA Impact Finance could track transactions and get a good idea of individual cash flow, which can help to predict default risk.
Financial access versus financial inclusion
Simon stressed that while these innovations have provided access to financial services for traditionally underserved communities, it is important for organizations working in financial inclusion to be cognizant of how increased access, without accompanying support for improving financial literacy, can lead to negative outcomes. Simon explained that it is a fundamental characteristic of human nature to overspend—and increasing access to services that could facilitate overspending can have negative impacts too. It is critical to provide education for individuals on the new tools at their disposal. Financial services firms have a responsibility, Simon argues, to increase financial literacy in tandem with access. The sector should continue to innovate in how to provide financial services in a manner that also can help with long-term development outcomes.
Photo courtesy of Flickr, licensed CC BY-SA 2.0.