From Subsidised Credit to Innovative Financial Broadening Strategies

Although we have seen in our review of empirical studies that the impact of microfinance on the incomes of the poor is not as promising as we would like to believe, it would still be wrong to argue that microfinance has had zero impact on financial broadening. In fact, in some countries microfinance can have a decisive role in the development of an inclusive financial system. Consider

the example of Cambodia (Helms 2006, 139), a country that had gone through 20 years of civil unrest destroying its entire financial system. Started by microfinance initiatives, the country now has around 20 licensed MFIs registered with the National Bank of Cambodia. During a five-year period (2004-2008), these banks together with NGOs engaging in microfinance, have reached over a million rural borrowers and more than 520 000 savers (IFC 2009). Hence, whether or not microfinance can be measured in terms of individual impact, it can certainly have a critical influence on the development of the financial sector at the system level.

A large part of the public policy debate on microfinance concerns the amount of resources allocated to MFIs and whether the sector should be subsidised at all. At a general level, MFIs are divided in financially self-sustaining commercial banks and NGOs dependent on subsidies from either private, public or international donor agencies. Subsidisation is generally defended by preventing excessively high interest rates and by deepening outreach to the poorest part of the population that cannot be reached profitably. Although arguments in favour of subsidised credit are well founded, both the lessons learnt from the failure of development banks to operate sustainably and the lack of evidence on the impact of subsidised microcredit point to another direction. In fact, evidence suggests that credit is not the tool that can make a considerable difference in lifting people out of poverty – simply because what the extremely poor really need is not credit, but nutrition, primary health care and education.

For most non-profit MFIs, however, microfinance is a program among others that range from educational and training programs to healthcare and family planning. If inequality is to be lowered by helping a large part of the population out of extreme poverty, subsidies should for the most part be allocated to investments in health and education. This point of view is supported by the study of Deininger & Liu (2009) on self-help groups in India that found no impacts on income, but positive impacts on nutrition, empowerment and the welfare of non-participants. We are not suggesting exclusion of extremely poor people from credit but rather do not see it as a first-aid solution meeting their primary needs. The risk of over-indebtedness resulting from credit is greater than the expected gain in welfare. As showed by Hulme and Mosley (1969) several decades ago, the increase in income is directly proportional to the starting level income – the poorer the borrower, the less impact on the loan (if impact at all). This phenomenon is supported by the studies reviewed in this paper.

Nevertheless, through livelihood training programs eventually contributing to employability, even the extremely poor do have a prospective way out of poverty. Mahajan (2007, 245) advocates for a paradigm shift from microfinance to “livelihood finance”, promoting sustainable livelihoods for the poor in the form of financial services (including savings, short-term and long-term credit, insurance for lives and livelihoods, infrastructure finance and investment in human development), agricultural and business development services and institutional development services. By meanwhile focusing on broadening access to credit constraint firms, the development outcomes rely for the most part, as we have seen, on the demand for labour.

It is thus crucial for policy-makers to identify the core needs of each income group when tailoring policies to target them. As previously argued, the population representing the lowest end of the income distribution should be provided with social sector programs instead of credit. However, extending non-credit financial services, savings services in particular, as far down as possible represents low risk to both the customer and the financial institution. Geographical barriers for savings services can be high, but access can be facilitated by technological solutions operating by mobile phones or the internet, which cover large parts of even the most remote areas in the world.

Mobile phone banking has proved particularly successful in the Philippines and in South Africa and other parts of Africa, demonstrating the potential that these technologies have in overcoming geographical barriers, but also requiring adaptation from the government at the legislative level (Demirguc-Kunt et al. 2008, 155). In addition, public authorities can insist on financial intermediaries introducing basic banking products for low-income customers in regions where they represent only a small fraction of profitable customers (Demirguc-Kunt et al. 2008, 157).

Although we advocate health care and education as the focus point of subsidisation instead of credit, we regard the expansion of commercial microfinance as highly beneficial for an inclusive financial sector. Honohan (2004) stresses the role of the mainstream financial system in expanding its outreach to credit constraint households. In fact, the convergence of mainstream and microfinance sectors will most likely keep strengthening as competition in the mainstream-banking sector intensifies. Claessens and Perotti (2005, 12-13) support the view of connecting microfinance to mainstream finance by showcasing examples on how providing finance to low-income groups can be profitable.

This paper has given substantial attention to information asymmetries as an important financial barrier. Government policies that promote credit information sharing and guarantee creditor rights

both aim at overcoming financial market imperfections arising from information asymmetries. Ex ante credit information facilitates the lender’s judgment on the creditworthiness of the borrower whereas ex post creditor rights ensure legal rights to the lender in case of default.

According to a cross-country study conducted by Djankov et al. (2005), both information sharing institutions and creditor protection through the legal system are correlated with financial depth as measured by private credit to GDP, however, creditor rights are shown to matter more in high-income countries. Demirguc-Kunt et al. (2008, 151) find this result particularly valuable, as building credit registries in developing countries is considerably easier than putting into practice sustainable improvements in the enforcement of creditor rights. Hence, efforts to broaden financial access in low- and middle-income countries should primarily focus on the strengthening of informational infrastructure by investments in both public and private credit registries.

However, broadening access still requires the support of well-designed policies and innovative technological solutions to overcome numerous regulatory, informational and geographical barriers.

Enhanced international cooperation can open up opportunities for positive spillovers in countries sharing similar geographical, infrastructural and cultural characteristics. At a general level, the essence of successful financial broadening policies lies in reinforcing the financial sector both at the extensive as the intensive margin.