Microfinance and Human Empowerment - Global Perspective

Dr.M.Prasadarao Registrar & Chief Admin Manager Institute for Technology and Management, Navi Mumbai ______________________________________________________________________________ On Awarding the Nobel Prize to Dr.Muhammad Yunus in 2006, former President of U.S. Bill Clinton said “The poor are credit-worthy and that a micro financing effort can be self-sustainable, create growth and spread peace”. Post 2009-10 Microfinance crisis in India and other countries many debates raised by re-Searchers, scholars and bankers about the authenticity of Microfinance as a movement or profitable business with a mask of empowerment of poor. Last two three years the Microfinance had witnessed severe ups and downs, establishment of increased no.of Microfinance Institutions (MFIs), increase of NABARD loans to banks under SHG Bank Linkage Program(SBLP), Launch of IPO by SKS, increase no.of credit related suicides. In India various legislative and regulatory provisions were made to empower or control the MFIs to sustain in their business activities. At the same time various countries in Asia and Latin America shown different pictures of sustainability. In this paper these aspects were drawn to assess the future process document for the Microfinance operation strategy. India: The Microfinance industry in India and worldwide is growing by the day. According to one recent study by Intellcap, the 60 largest microfinance institutions in India have 10 millions of working poor who have been given small loans that allowed them to pull themselves and their family out of poverty. Microcredit has become a global fad, to the point where all kinds of claims are being made in its name, as if it is the latest magic potion to resolve the problems of poverty in the world. In response, a range of others, from the Wall Street Journal to academic researchers like Jonathan Morduch have taken it upon themselves to question these claims and show that the impact of microcredit on the target households is exaggerated. The effectiveness of microfinance as a universal poverty reduction tool. It argues that while microfinance has developed some innovative management and business strategies, its impact on poverty reduction remains in doubt. Microfinance, however, certainly plays an important role in providing safety-net and consumption smoothening. The borrowers of microfinance possibly also benefit from learning-by-doing and

from self-esteem. However, for any significant dent on poverty, the focus of public policy should be on growth-oriented and equity-enhancing programs, such as broad-based productive employment creation. “There are many stories of the transformative effect of microfinance on individual borrowers but until recently there has been surprisingly little rigorous research that attempts to isolate the impact of microfinance from other factors, or to identify how different approaches to microfinance change outcomes.”

Professor Mohammad Yunus, the founder of Grameen Bank in Bangladesh and the originator of the concept of microfinance, believes that 5% of Grameen Bank’s clients exit poverty each year. However, there are surprisingly few credible estimates of the extent to which microcredit actually reduces poverty. Even the Ideally one can ascertain the impact of microfinance if the counterfactual—what would have happened to a person who borrowed from a microlender if he/she had not done so—can be easily tested. Many early studies compared borrowers with non-borrowers. But if borrowers are more entrepreneurial than those who do not borrow, such comparisons are likely to grossly overstate the effect of microcredit. Two recent studies attempted to overcome the problem of self-selection (i.e, the likelihood of people with entrepreneurial skills borrowing) by using randomized sample selection methods.6 That is, participation in a programme is determined essentially by chance. Contrary to the usual claims, neither study found that microcredit reduced poverty. Microcredit may not even be the most useful financial service for the majority of poor people. Microfinance and micro-credit are used interchangeably here. However, in the literature, microfinance is also used in a broader sense to cover financial services such as micro savings and micro insurance. Poor households do not benefit from microfinance; it is only non-poor borrowers (with incomes above poverty lines) who can do well with microfinance and enjoy sizable positive impacts. More troubling is the finding that a vast majority of those with starting incomes below the poverty line actually ended up with less incremental income after getting micro-loans, as compared to a control group which did not get such loans.

Too many micro-enterprises due to a constant inflow of new MFI financed entrants cause ‘market saturation’, and a hyper-competitive situation. This results in very low, and declining, rewards for such simple micro-enterprise activities. The recent crisis of Microfinance and regulatory interventions are ignited by the cases of so-called suicides by the farmers in Maharashtra and Andhrapradesh is fuelled the debate on the interest rates being charged by many MFIs. The cap of 26% decided by the RBI, which nearly killed many

young MFIs doing “business” perhaps with the face “empowerment of poor”. If the main reason of the suicides is inability to repay the loans, we shall research for the reasons of non-payment. The absence of micro-enterprises supported by less market for the products they manufacture are and auxiliary reasons for the increasing bad debts. Without an expanding domestic market, new entrants into a landscape of too many micro-enterprises will be like a moral tale. Two partners jointly set up a grocery shop. They are very excited about their prospects for becoming rich. But their enthusiasm gradually wanes as they wait for their first customer who never shows up. One of them finds a solution. She borrows some extra money and buys from the shop. This generates some income for her partner, who uses this to buy from the shop. This buying and selling from each other continues until the stock finishes. In the process they may smooth their consumption, but end up with a larger debt! Bangladesh: There is no one single solution to global poverty. Dr. Yunus says “Micro-credit is not a miracle cure that can eliminate poverty in one fell swoop. But it can end poverty for many and reduce its severity for others. Combined with other innovative programs that unleash people’s potential, micro-credit is an essential tool in our search for a poverty-free world”. Households with an existing business at the time of the program invest in durable goods, and their profits increase. Households with high propensity to become business owners see a decrease in nondurable consumption, consistent with the need to pay a fixed cost to enter entrepreneurship. Households with low propensity to become business owners see nondurable spending increase. The supply of microcredit does not necessarily ensure the availability of complementary factors in adequate quantities and quality. Some microfinance institutions and non-government organizations (NGOs) seem to have understood the need for such factors and, therefore, also offer training to build management and entrepreneurial skills. There are also NGOs (such as BRAC in Bangladesh) which provide basic education in rural areas using innovative methods. These are all potentially positive developments for poverty reduction efforts. This modest income gain happened in the context of rapidly expanding garments production in Bangladesh. The World Bank study compared households in the sample between 1991–1992 and 1998–1999. Then it would have been an interesting counter-factual to see what would have happened in the absence of the fast expanding garments industry in Bangladesh. Fortunately, the garments sector still managed to grow, thanks to the resilience and ingenuity of the entrepreneurs in Bangladesh, and to the buoyant world economy. In sum, microfinance is not a panacea for poverty reduction, which needs both complementary supply-side and demand-side factors. Supply-side factors— such as good infrastructure, entrepreneurial skills, etc.—are needed to make

micro-enterprises more productive. But the potential for increased productivity will remain mostly unrealized in the absence of demand-side factors. In other words, without a supportive macroeconomic, trade and industry policy framework, micro-enterprises will remain micro, with no backward or forward linkages or employment creation possibilities. This is the crux of the so-called graduation problem of micro-borrowers, as highlighted in a recent editorial in the Daily Star (Dhaka, Dec. 12, 2008): “so long as this is not complemented by the government’s facilitating growth of marketing network, reliable energy supplies and a dose of fiscal incentives to the small exporters, the full potential of the micro-credit sector would remain untapped.” Returns to investment and interest rates More than anything else, the interest rates charged by microfinance institutions (MFIs) draws most vigorous criticisms. Where the interest rate is at the lower end, it is often due to implicit subsidies. Vijay Mahajan (2005) puts this argument forcefully: “If the implicit subsidies to microcredit institutions are made explicit, then subsidizing microcredit programmes versus subsidizing social sector programmes can become an informed policy choice, rather than be carried out under the mistaken notion that the former will require only temporary and diminishing subsidies. But the implicit subsidies to microcredit, legitimate as they may be, are not being described or analysed.” Thus, some proponents defend this by arguing that it is still less onerous than the alternatives. For example, according to Karol Boudreaux and Tyler Cowen (2008), “That’s not as scandalous as it sounds local moneylenders demand much higher rates”. Others defend the high interest rates by claiming that the returns to capital are, indeed, high in micro enterprises. But Jonathan Morduch (2008), an advocate of microfinance, makes an important, but moot acknowledgement: “The microfinance movement rests largely on one basic assertion: that poor households have high economic returns to capital.”

Expansion of Microfinance: “The UN’s 2005 ‘Year of Microcredit’ marked the long journey of microcredit from an obscure experiment in the mid-1970s to the status of a worldwide movement. Microcredit has captivated not just the entire development aid industry, but journalists, editorial writers, policy makers and much of the general public in both the North and the South. Virtually every development project I see these days, from maternal and child health, to women’s education, to soil conservation, to social forestry, to old fashioned integrated rural development, has a ‘microcredit component’, and everyone from camel herders in Mauritania to peasants in rural China can speak the lingo. Pankaj Jain and Mick Moore of the Institute of Development Studies (UK) and

David Roodman and Uzma Qureshi of the Center for Global Development (USA) have attempted to explain the microcre dit movement’s rapid growth and international support. Based on an extensive survey of the literature and interviews with its leading players, Roodman and Qureshi (2005) claim that the success of microfinance is due to innovative business practices involving product design and management, and enabling environments. Roodman and Qureshi (2006) conclude, “Microcredit, like all credit, helps some people—one hopes, the majority of clients. And like all credit, especially when pushed hard by suppliers, microcredit must hurt some clients too.…[T]he historical emphasis among MFIs on credit rather than savings appears to have arisen for practical business reasons rather than because it has been shown that credit helps clients more… Microfinance investors should therefore work to understand how MFIs succeed on both bottom lines—as businesses and as agents of development.” There is a little evidence to support three core claims of microfinance movements: strong social bonds among small borrowers, substantial borrower participation in management and unsubsidized interest rates. The real explanation for their success lay in careful attention to managerial and strategic ‘fundamentals’. These include keeping transactions costs low, matching loan payment schedules to borrowers’ income and savings potentials, finding ways of obtaining good work performance from large and widely dispersed field staff, etc. In addition to a business model explanation, Jain and Moore give a political economy explanation for the success of the microfinance movement. According to them, microfinance campaigners successfully projected the image of the movement, such as empowerment of women, which resonates well with the donor community. The birth of the movement roughly coincided with the rise of neo-liberal ideas in the US and the UK, and within the Bretton Woods institutions in the late 1970s and early 1980s. Thus, the notion that microfinance programs are primarily engaged in the promotion of small scale enterprises appealed to major donors. While donors were wary of subsidized credit through state-owned specialized financial institutions, they were quite happy to subsidize microfinance institutions as they appeared to promote a market economy, and more importantly, they helped to diminish the role of the government. The reality is that the supply of credit and other complementary supply-side factors cannot drive the growth of viable businesses if the market itself does not expand rapidly. This can only create debt-burden or underutilization of credit and a downward pressure on the returns to investment. There is a clear parallel in the labour market. In the early days, after independence, many countries invested heavily in higher and technical education. But as their overall policy framework failed to generate employment intensive growth, the supply oriented human resource policy only contributed to swelling educated or graduate unemployment. This not only amounted to

wasteful under-utilization of graduates, but also contributed to the decline in returns to higher education due to over supply. Contributions of microfinance: Microfinance can help the poor smooth consumption over periods of cyclical downturns or unexpected crises. This positive role of microfinance should not be dismissed altogether. If this consumption smoothing means parents can send their children to school, or buy essential medications, and maintain nutritional in-takes of their children then microfinance is likely to have positive long term impacts on productivity. But in a situation of generalized poverty or economy-wide crisis, the poor will have to go to money lenders or to the employer/landlord for whom she or he works. If MFIs extend lending to the very poor in these circumstances then they can help break the power and hold of such creditors who operate in the inter-locking credit and factor markets. Although high, the interest rates charged by the MFIs are lower than the rates charged by informal creditors (money lenders/employers/landlords). Unfortunately, however, most MFIs have been found lacking when it comes to lending to the very poor. Nonetheless, it seems that microfinance has significantly dented the informal credit markets by undermining debt-bondage and usury in some agrarian societies. Thus, microfinance is having a modernizing impact, even if inadvertent, unacknowledged and unsung. More importantly, by “democratizing” the credit market the microfinance movement has not only curtailed the power of money lenders, but also constrained MFIs’ own behaviour. In other words, the rapid expansion of microfinance has empowered not just women, but all small borrowers. Even if they do not participate effectively in MFIs’ decision making or management (as found by Jain and Moore), the ability of the MFIs to foreclose on any tangible property of loan defaulters seems to have shrunk significantly. So, one should not be surprised by the findings of the Wall Street Journal’s reporters that Grameen was often rolling over unpaid loans. Whether Grameen was driven by any humanitarian consideration or forced to do so to avoid bad publicity is, of course, moot. Inter-locking credit and factor markets is a feature of the semi-feudal agrarian relationship where farmers depend on their landlords for work There is also the learning-by-doing effect. Even when own labour in microenterprises is given a zero shadow price, the people who are involved benefit. They learn some basic principles of business, and with luck, and perhaps some help, may be able to become more viable and even expand. This is akin to apprenticeship where the apprentice gets a low wage, but in exchange, gets training in a trade. So, with their support and training programs, many MFIs are making some useful contributions. Microfinance, thus, gives the unemployed and the poor some opportunities, hope and self-esteem.

Being employed (whether self-employed or by an employer) gives a person a significant boost to his/her sense of self-respect and dignity. Furthermore, microcredit allows people to signal their creditworthiness. If their success makes banks more willing to lend them larger sums and leads to even more economic activity, then that should help reduce poverty in the long run. Microfinance is making some important positive contributions, which many of these effects cannot be measured in monetary terms, and hence will remain largely unacknowledged in the literature focused on the traditional income or expenditure measures of poverty. The question, nevertheless, remains as to how long microfinance can continue to provide consumption-smoothing support or extending the payments schedule. To be able to serve as a viable poverty reduction strategy, micro-credit financed enterprises must expand and create decent jobs for the growing labour force. It is often claimed that the greatest discovery of the Grameen-led microfinance movement has been the credit worthiness of the poor. Related to this has been the discovery of the dynamism of micro-enterprises. In reality, however, neither is new. The poor have been borrowing from money lenders (landlords) from time immemorial. Micro-enterprises have been operating for a long time in many poor societies, and form the vast informal sector associated with developing countries. However, the real discovery is the concept of “group lending” which effectively overcomes the problems of collateral and adverse selection due to information asymmetry through peer monitoring. Impact analysis of microfinance suggests that the majority of borrowers who already have some assets (or business skills and education) are more likely to succeed. The owner operators of these micro-enterprises have already proven their entrepreneurial acumen, but they face numerous constraints ranging from inability to access the formal credit market to marketing their products. These enterprises should be supported with easy access to credit and other financial services (e.g., insurance).

Recognizing this, the United Nations has advanced the idea of “inclusive” finance as an integral part of financial sector development. To quote, “There needs to be a continuum of financial services available to households as they increase their standards of living and for enterprises as they grow into the business mainstream. This is a critical issue for the development of financial sectors. It involves adequate financial services for small and medium-sized enterprises (SMEs) often called the ‘missing middle’, as well as the smallest mircroentrepreneurs.”

Indonesia: There are several explanations for Indonesia’s impressive performance in the literature. While there are some disagreements about the role of liberalization and market reforms, all agree on the role played by the

state in promoting labour (employment) intensive industrialization and agriculture with a variety of schemes. These included: massive investment in infrastructure, especially in rural areas and the outer islands, and in irrigation projects supply of subsidized agricultural inputs (in particular fertilizers) price support for rice farmers (through BULOG–a marketing board) rural savings and credit programs (Bank Rakyat Indonesia–BRI) competitive real exchange rate through successive devaluations and managed depreciations.

In contrast to the microfinance movement, the rural credit scheme of Indonesia through the Bank Rakyat Indonesia (BRI) emphasized savings, not credit. India, in following an import substituting industrialization (ISI) policy, was influenced by the Soviet model of heavy industrialization, which the celebrated Indian planner, P.C. Mahalanobis, described as “machine to produce machine”. Thus, the capital intensive ISI failed to create enough employment; the domestic market did not grow rapidly to absorb the growing labour force while the industrial sector suffered from over-capacity. As such it was not the fault of ISI, but the capital-intensive nature of industrialization that failed. ISI can be followed equally for labour-intensive industries, and this is the lesson we learn form the experience of successful East and Southeast Asian economies. The labour-intensive industrialization strategy has another advantage; it helps reduce income inequality. This is evident from Indonesia’s experience. Microfinance Paradigm Shift: The microfinance campaign led by the legendary Dr.Muhammad Yunus, today the microfinance institutions are growing rapidly. Philippines: Today, 1,200 Micro Financing Institutions are operating in the country since its inception in 1980’s. The Filipino entrepreneurs, investors, institutions and Christian organisations that in the form of SME have influenced their lives and economy. Nearly 2.2 million poor million Filipino families were benefited by the microfinance players since 2005. The MFI will be growing by heaps and bounds, especially when our economy is hanging in the balance. Micro entrepreneurs need money on the right time. If they need it, they will resort to MFI as there a vacuum in provision of rapid and easy loans system. In Philippines or any country the MFI loans system is not a strict and conventional banking or any other financing system. The micro purposes and micro and easy process, supported by entrepreneurial activities in Philippines encouraging the investors. Even Philippine government made Microfinance industry as an official tool in poverty reduction through the social reform and poverty alleviation Act (Republic Act 8425)

Despite the success of Philippine microfinance sector majority of the MFI’s are still institutionally weak to spread the “manna” or rather “bread from heaven” and saturate the poorest provinces or the frontier areas. The challenge in Philippine micro financing is whether MFI could operate on rural areas where main economic and business activities are farm-based and farm-related enterprises. Spirituality: Investors and clients both profit financial and gain moral and spiritual uplifting because in Chritstian MFI, the industry is spiced-up with social responsibility and accountability and aims for life transformation. PCFC (People’s Credit and Finance Cooperative), a government financial institution tasked to wholesale funds to MFI reports 98% loan repayment rate.

Social Commitment/Group Dynamics: When crisis strikes, the company and the clients are working out for the good, changes and challenges are easily overcome due to contextualization and constant social communion existing between the staff and the clientele. Factors Influencing Microfinance Sustainability: The Microfinance clients are influenced by various human relation and group dynamics as follows: a) b) c) d) e) f) g) Conditions at Family Spiritual and Ethical Physical and Health Financial and Professional Social and Cultural Community and Social Political and Government interface

Bolivia: In comparison with India the microcredit program has entered and popularized much before in Bolivia. In early 1980s microfinance has initiated it’s beginning by incorporating innovative guarantee schemes, as in the case of solidarity group guarantees. The Confederation of Private Entrepreneurs of Bolivia, the Calmeadow Foundation and ACCION International provided the incentive for these innovations, and promoted the creation of the Foundation for the Promotion and Development of the Microenterprise (PRODEM) in 1986.

Two years after its creation, the success of PRODEM was evident, to such an extent that it became difficult to attend to the growing demand in a sustained fashion. This unsatisfied demand, amongst other factors, lead to the creation of Banco Solidario (BancoSol), initiated in 1988 and completed in

1992. Since then, BancoSol remains the only Bolivian bank with services directed exclusively to the microenterprise sector. In addition to PRODEM, other NGOs have been formed to target the microenterprise sector, applying various credit methodologies. Some examples include the Foundation for Alternative Development (FADES), founded in 1988 and oriented exclusively to rural sectors and recognized for its methodology of “associative credit”,and the Center for the Promotion of Economic Initiatives (FIE), founded in 1985 which pioneered the financial services. On the other hand, the Institute for the Development of the Small Productive Unit (IDEPRO), was founded in 1986 with the objective of providing business development services as a complement to their financial services. IDEPRO started its Financing activities in 1991, several years after its creation. the development of microfinance in Bolivia describes the advances in this sector with respect to credit technologies, geographical coverage, institutional development, the legal framework and the role of the government and of donor institutions. The work of various non-governmental organizations (NGOs) has transformed what was once considered “taboo” - lending to the poor and those involved in the informal market - into a flourishing, profitable activity which has had a visible social and economic impact on an important segment of the Bolivian society. In over 10 years of activity, the primary lesson learnt is that the market must respond to the needs of the people, and as a result different technologies have been developed ranging from solidarity groups to individual credit, covering a gamut of schemes which have proved their effectiveness in allowing access to credit. The development of these technologies has been accompanied by important advances in institutional development, forced -to some extent- by the growing demand and the restrictions embedded in the norms established by the regulatory and supervisory authorities of the financial system. Organizational structures have been modified to improve the management, administration, and credit/financial policies to become more efficient. Throughout this process, various NGOs have decided to create autonomous entities, specialized in microfinancing, with a profit motive, although the aim of providing assistance to the most needy segments of the population remains. The necessity of meeting regulatory guidelines and of covering a wider geographic area of the country has forced many of these entities to increase their equity, and as a result they have their institutions to socially oriented organizations (domestic and foreign) and individuals. This document also highlights the creation of two microcredit associations, one of financial entities that work in urban areas and a second of those in the rural areas, with the goal of offering services of common interest to their members. (Note : Studies are underway to fuse these two associations into a single institution.) The government played a very limited role in the development of the microcredit market. First the Popular Microcredit Program (PMP) was

established to provide grant funds for portfolio and institutional strengthening of several financial NGOs. Subsequently, the Rural Financing and Microcredit Aid Program (PAM) was developed to cover a broader spectrum of financial and non-financial aid, although it was never fully implemented. Finally, the current government has just defined the strategy of a Microcredit Fund to provide financing and institutional strengthening to MIs. Throughout these developments, international donors have had and continue to play a very active role. Credit Technologies: In response to the existence of very heterogeneous markets within Bolivia, various types of institutions have developed which apply diverse credit technologies to reach the micro-entrepreneur. The following is a brief description of the different technologies applied in Bolivia, including an example of an institution in each case. a. Solidarity Groups: General Characteristics: The technology of solidarity groups is the most well-known, both nationally and internationally. PRODEM was the pioneer of this type of service, which has subsequently been adopted by various other institutions , although in some cases this technology has been combined with others of the individual or associative type, or with other non-financial services as in the case of PRO MUJER, as will be discussed. The principal characteristic of the solidarity groups is the use of an intangible guarantee, called a community guarantee, although the credit is approved individually. This type of guarantee is based on the compromise of all the members of the group to assume responsibility if one of the members of the group fails to make payment. These loans are not targeted and can be used for any need deemed necessary by the borrower. Finally, these credit lines are sequential, in that the group starts with small loan amounts which can grow over time as the group meets its financial obligations.

b. Individual Credit: General Characteristics: This technology was introduced mainly by the international cooperation, above all that of Germany. Its principal characteristic is an individual guarantee, which allows the clients to formulate their own business plan in accordance with the business activity in which they are involved. This method provides an alternative for those mircroentrepreneurs who either do not want to or cannot participate under solidarity credit schemes, and whose only funding alternative is through informal mechanisms. This technology is also used for those entrepreneurs who normally need larger amounts of credit than those granted through solidarity groups, and are able to provide other guarantees. Some institutions which only work with solidarity groups have been forced to introduce the individual technology, as in the case of PRODEM, to respond to the needs of their clients. There are also other institutions, such as Los Andes, which exclusively provide funds using this technology

c. Associate Credit: General Characteristics: The development of this technology is based on an established organization (association or cooperative), whose function is the intermediation of funds given by the financial institution for its members. In the cases studied, these funds are used by the organization's members, largely producers, mostly in investment capital. This type of financial services is provided by institutions such as ANED,FONDECO, IDEPRO and FADES. In some cases, this credit complements other types of services (such as technical assistance) which can be provided by the same institution or by a separate NGO. d. Communal Banks: General Characteristics: A communal bank is formed by a group of individuals who take the responsibility for the administration and repayment of the funds received from the financing institution, generally called the Executing Institution. The Executing Institution organizes the communal bank and provides the initial funding. The group, as a whole, guarantees the loan. , consisting of funds supplied by the Executing Institution, and the Each communal bank names a credit committee charged with the administration of the is composed of two sources; the first, is the savings of the members of the communal bank, which is a requirement to have access to credit, and they are deposited in a bank account in the financial system under the name of the communal bank, and the second source is the interest generated on the external account during the loan cycle of approximately 4 months. Once the funds of the Executing Institution are received, these are continually relent among the borrowers of the communal bank, given that the members make weekly payments on both capital and interest. e. Credit and Non-financial Services: General Characteristics: Microenterprises face a series of restrictions, including lack of access to markets, to information and technology. Non-financial services are designed to overcome these restrictions and thus improve the performance of the microenterprises. In many cases the services are offered alone, and in others, jointly with financial services. These services are not necessarily a prerequisite to access to credit, as in the case of IDEPRO, an institution which has been able to achieve an integrated operating strategy where the offer of business development services is only a complementary option to the financial services extended by the institution. f. Combination of credit technologies: General Characteristics: The development of microcredit in Bolivia, has given rise to innovation, not only regarding the development and implementation of new credit technologies to attend to a given client base, but also in terms of an adequate combination of the existing technologies to provide an improved coverage of the services offered. At the same time, these institutions are taking advantage of the new regulations of the SBEF to deepen financial

intermediation as they transform into FFPs. Second Tier Institutions: General Aspects: “Second-tier” institutions have developed in response to the financing needs of financial intermediaries, whose loan portfolios have grown rapidly in recent years. Currently there are two institutions which directly supply funds to microcredit institutions, the Foundation for Production (FUNDA-PRO) and the Bolivian National Finance Corporation (NAFIBO) S.A.M. Services Offered: Financing. FUNDA-PRO has two financing programs: institutional and educational. Under the institutional credit program, it channels funds through legally established financial intermediaries with the aim of providing support to the productive activities of the micro, small and medium enterprise which confronts difficulties in accessing credit. Through its educational credit program FUNDA-PRO provides financial assistance for master's degree programs, technical or specialized courses and thesis completion. Bolivian National Finance Corporation: General Aspects: The Bolivian National Finance Corporation (NAFIBO) S.A.M. is a second-tier financial entity whose objective is the intermediation of medium and long-term funds to private financial institutions legally established in the country, which then channel these resources to the private and productive sectors of the economy. An Agreement signed between the Bolivian government and the Andean Development Corporation (CAF) in 1994, decided the closing of the Development Division of the Central Bank of Bolivia and, instead, the creation of NAFIBO. In October 1995, the National Congress approved the Law of the Central Bank of Bolivia Nº1670, which ratified the aforementioned Agreement and also authorized the creation of second-level financial entities. In September 1996, NAFIBO received its operating license from the SBEF to initiate operations. Its first credit operation was with Los Andes, a financial fund dedicated exclusively to microcredit activities. Development programs. FUNDA-PRO has developed programs for the strengthening of non-bank financial entities, the opening of new markets, research concerning topics in microcredit and the development of financial services in rural areas. Institutional Development: a. Non-Governmental Organizations: Non-governmental organizations, also called private development institutions (IPDs), are civil non-profit associations which, under the Civil Code, can perform financing and granting activities with government and external funds. The IPDs are the principal source of funds for the low-income population, both in the urban and rural areas. However, while

institutions are not currently regulated by the SBEF, the monetary authorities have recognized their importance in channeling resources to regions where conventional banks do not find profitable, and the plan of the current government contemplates their regulation as financial intermediaries.

b. Private Financial Funds: From the point of view of regulated entities, the microcredit market was considered unattractive and was perceived as being high-risk with low return. This may be due to the fact that these institutions did not apply appropriate credit technologies to attend to this market segment. From the point of view of the financial NGOs, the greatest restrictions were : the dependence on financing from donor organizations and the inability to raise funds from the public. In consequence, it was deemed necessary to create a new type of financial intermediary to attend to this market segment largely ignored by commercial banks, under a legal framework called a private financial funds (FFPs). The FFPs were created to finance the activities of the medium, small and micro enterprises in the productive, commercial and individual consumption sectors. The principal norms applied to these type of institutions are summarized in section VI.C1. C. Cooperatives: Cooperatives have operated in Bolivia since the 1950´s, and since their establishment have provided microcredit services. Regarding financial performance, the savings and loan cooperatives have had very unequal development. Cooperatives have experienced some very strong crisis periods, especially in the 1970´s, and as a result many of them present weaknesses regarding the quality of their loan portfolio and in their administration.17 In order to assist in their strengthening, the World Council of Credit Unions (WOCCU) and the Confederation of German Cooperatives (DGRV) are working on different programs. According to a survey of savings and loan cooperatives in 1993, performed by WOCCU, the number of cooperatives in the country is 278, of which only 3 are licensed for operations. In general, the cooperatives attend to the financing needs of merchants, professionals and individuals, and to a lesser degree to the productive sector d. Associations: Corporation of Private Institutions to Assist the Microenterprise: The Corporation of Private Institutions to Assist the Microenterprise (CIPAME) was founded on May 10, 1993 and was granted legal status in 1994. To date it has eight affiliate institutions, six of which provide financial services and the remainder other types of services, all in urban centers. These institutions are : the Center for the Promotion of Economic Initiatives (FIE), the Institute for the Development of the Small Productive Unit (IDEPRO), the Center for Research and Regional Development (CIDRE), the Banco Solidario S.A. (BancoSol), the Center for Integrated Services for Urban Development (PROA), the Center for Research of Labor and Agrarian Development (CEDLA), the Bolivian Foundation for Women´s Development

(FUNBODEM) and Catholic Relief Services - USCC (CRS). The objectives of CIPAME are to provide services to its members and coordinate and represent their interests Association of Financial Institutions for Rural Development : The Association of Financial Institutions for Rural Development (FINRURAL) was created on September 28, 1993. Its members are : the National Ecumenical Association for Development (FADES), the Foundation for Alternative Development (FADES), the Fund for Communal Development (FONDECO), the Foundation for the Promotion and Development of the Microenterprise (PRODEM), the Foundation SARTAWI and Freedom from Hunger. Law of Banks and Financial Entities : The Law of Banks and Financial Entities of April 14, 1993 was the culmination of a process of financial reform started in Bolivia in 1987 whose objective was the strengthening of the banking system and the expansion of its role of assigning resources to different sectors of the economy. In order to achieve these goals, the Law focuses on assuring monetary stability and establishes the requirements for an adequate development of financial entities e. Law of the Central Bank: The Law of the Central Bank, approved on October 31, 1995, establishes that this entity is the sole monetary and exchange rate authority of the country, with the primary objective of maintaining the purchasing power of the local currency. According to its Article 31, the Central Bank of Bolivia is also the only institution responsible in issuing norms regarding the financial system. In addition, in its role as the governing body of the financial system, the Central Bank is charged with executing the monetary policy, regulating the quantity of money in the economy and the volume of its credit in accordance with the monetary program. Regarding second-tier banks, Article 31 clause i) of the Law refers to these entities, and Articles 84 and 85 of the same explicitly approve the creation of NAFIBO as a mixed autonomous corporation Future Challenges: a. Savings Mobilization: A large part of microcredit services has been developed from the supply-side, generally as the preconception has been that providing services to the poorest segments of the population is not profitable or that they have to be subsidized. Therefore, the development of other financial services has been very limited, specially in the area of savings movilization. Attracting savings is a source of funding, as external financing decomes ever more scarce. This presents a challenge to microcredit institutions. Just as the research and diffusion of results was important in the development of microcredit, it is equally necessary to support this kind of work in relation to savings. Improving the knowledge regarding the mobilization of savings is key to adequately design and implement strategies for

attracting savings b. Access to Financial Services in the Rural Areas: Rural areas in Bolivia are inhabited by the poorest segments of the population. The limited presence of financial services in many regions even non-existent in same areas, inhibits the development of economic activities of their population. The majority of the resources channeled to rural areas come from NGOs or IPDs, which are generally not sustainable and in addition confront a scarcity of resources. Currently only one FFP is timidly offering financial services in rural areas. In addition to these restrictions there are diverse structural limitations in the rural economy, including legal and regulatory problems regarding land ownership, guarantee problems and a deficient physical infrastructure, aspects which discourage formal financial institutions such as banks and make the work of IPDs more difficult, increasing the costs of their operations. It is necessary to promote financial intermediation in the rural areas to permit the rural populations to gain access to financial services. c. Regulation of Financial NGOs: All of the financial entities involved in the microcredit sector should be subject to the same rules and regulations to assure transparency and avoid unfair competition with those institutions which have achieved a greater degree of development and are in the process of converting into FFPs. Even though many of these institutions, above all NGOs, are located in regions with difficult access, this is not a sufficient rational for the total lack of regulation. Also many of these institutions do not have a longterm vision for their operations, and as a result it is possible that many will not survive in the market for long. Establishing clear rules permits a degree of “consumer protection”, the true principal protagonist in the microenterprise sector. The lack of these rules works against credit education in that these institutions can attract clients but are not forced to take on the corresponding responsibility On the other hand, there are those who point to the success of certain microcredit institutions in light of the lack of a regulatory framework as evidence that governmental regulation is unnecessary. Although this conclusion is strictly correct, it is important to take into account that current market conditions are very different, as are the possibilities for access to future financing sources.

References: 1. http://www.microfinancegateway.org/content/article/detail/31747?pri nt=1 accessed on Dec. 9, 2008.

2. Jomo K. S. [ed.] (2001). Southeast Asia’s Industrialization: Industrial Policy, Capabilities and Sustainability. Palgrave, Houndmills.

3. Khandker, Shahidur R. (2005). “Microfinance and Poverty: Evidence Using Panel Data from Bangladesh”. World Bank Economic Review, 19 (2): 263–286. 4. Mahmud, Wahiduddin. (2008). “Bangladesh”. In Anis Chowdhury and Wahiduddin Mahmud (eds) (2008). Handbook on South Asian Economies. Edward Elgar, Cheltenham.

5. Mahajan, Vijay (2005). “From Microcredit to Livelihood Finance”. Economic and Political Weekly, October 8.

6. Boomegard, James, James Kern, Calvin Miller and Richard Pattern. 1992. A Review of theProspects for Rural Financial Institution Development in Bolivia. Technical Report No. 31. Gemini. Bethesda, Maryland.

7. Fisher, William, Jeffrey Poyo and Ann Beasley. 1992. Evaluation of the Micro and SmallEnterprise Development Project in Bolivia. Technical Report No. 42. Gemini. Bethesda,Maryland. 8. CAMACHO Efraín. Private Financial Funds. Alternatives for the Financing of the Small and Micro Enterprise. IBEE, La Paz, July 1995

9. Central Bank of Bolivia. Informative Bulletin No. 48. Year 4, March 1997.

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