MICROFINANCING

INTRODUCTION
Microfinance has evolved as an economic development approach intended to benefit
low-income women and men. The term refers to the provision of financial services to
low-income clients, including the self-employed. In addition, savings and credit are the
most common financial services provided by microfinance firms; however, some also
offer insurance and payment services.

Moreover, many MFIs offer social intermediation services in addition to financial

intermediation, such as group formation, self-confidence building, and financial literacy
and management training for group members. As a result, financial and social
intermediation are frequently included in the concept of microfinance. Microfinance is a
development tool, not only a form of banking.

Microfinance activities usually involve:

■ Small loans, typically for working capital - microcredit
■ Informal appraisal of borrowers and investments
■ Collateral substitutes, such as group guarantees or
compulsory savings
■ Access to repeat and larger loans, based on repayment
performance
■ Streamlined loan disbursement and monitoring
■ Secure savings products

Although some MFIs provide enterprise development services, such as skills training
and marketing, and social services, such as literacy training and health care, these are
not generally included in the definition of microfinance.

BACKGROUND
Microfinance began in the 1980s in response to concerns and study findings concerning
the government's provision of subsidized loans to impoverished farmers. In the 1970s,
government agencies were the most common source of productive credit for those who
had previously had no access to credit—those who had been compelled to pay usurious
interest rates or were exposed to rent-seeking activity. Governments and international
donors felt that the poor needed low-cost finance and regarded this as a means to
encourage small-scale farmers to produce more food. In addition, donors established
credit unions modeled after the Raiffeisen model introduced in Germany in 1864, in
addition to offering subsidized agricultural finance. The focus of these cooperative
financial institutions was mostly on savings mobilization in rural areas in an attempt to
“teach poor farmers how to save.”
Moreover, the field of microfinance has grown significantly since the 1980s. Donors
actively fund and encourage microfinance activities, with a particular focus on MFIs that
are devoted to large-scale outreach and financial sustainability. Today's concentration is
solely on financial services, whereas the 1970s and much of the 1980s were marked by
an integrated package of loans and training—which need government subsidies.

WHY IS MICRO FINANCE IS GROWING?

Micro finance is growing for several reasons:
1. The promise of reaching the poor. Microfinance activities can help low-income
households generate revenue through their businesses.
2. The promise of financial sustainability. Microfinance operations can aid in the
development of financially self-sufficient, subsidy-free institutions that are often
controlled locally.
3. The potential to build on traditional systems. Microfinance activities might be
confusing since they resemble traditional systems (such as rotating savings and
credit associations). They provide similar services in similar ways, but with more
flexibility, at a lower cost to microbusinesses, and on a longer long-term basis.
Microfinance services may become particularly appealing to a large number of
low-income clients as a result of this.
4. The contribution of micro finance to strengthening and expanding formal
financial systems. Microfinance operations can help to enhance existing formal
financial institutions. Savings and loan cooperatives, credit union networks, and
commercial banks are examples of financial institutions and even state-owned
financial institutions, by broadening their savings and loan markets—and their
profitability could be affected.
5. The growing number of success stories. In places as disparate as rural
Bangladesh, metropolitan Bolivia, and rural Mali, there are a growing number of
well-documented, microfinancing success stories.
6. The availability of better financial products as a result of experimentation
and innovation. The innovations that have shown most promise is solving the
problem of a lack of collateral through group-based and character-based
approaches; solving problems of repayment discipline through high frequency of
repayment collection, the use of social and peer pressure, and the promise of
higher repeat loans; and solving problems of transaction costs by shifting some of
these costs down to the borrower.

WHAT ARE THE RISKS OF MICROFINANCE?

Microfinance operations that are based on best practices play a critical role in ensuring
that the disadvantaged have access to financial services through sustainable institutions.
However, there have been many failures than successes:
• Because of a lack of markets, inputs, and demand, some MFIs target a portion of
the population that has no access to business prospects. Without other inputs,
 productive credit is useless to such people.
• Many MFIs never reach either the minimal scale or the efficiency necessary to
cover costs.
• Many MFIs face non-supportive policy frameworks and daunting physical, social,
and economic challenges.
• Some MFIs fail to properly manage their finances in order to meet future cash
needs, resulting in a liquidity problem.
• Others develop neither the financial management systems nor the skills required to
run a successful operation.
• Replication of successful models has at times proved difficult, due to differences
in social contexts and lack of local adaptation.
In the end, most of the microfinance issues and problems stem from a lack of clarity
about the organization's primary purpose. Is microfinance available through an MFI to
help people get out of poverty? Or to promote economic development? Or to assist low-
income women in gaining confidence and become more empowered within their
families? And so forth. Goals are a matter of choice in some ways, and in development,
an organization can choose one or more aims, as long as its constituents, governance
structure, and finance are all aligned with those goals.

MODULE 1
MICROFINANCE – AN INTRODUCTION

Microfinance is influenced by a country's general political and economic situation.

Microfinance organizations' delivery of financial services to the poor is influenced by
government economic and social policies, as well as the financial sector's level of
development. Assessing the country context is the process of determining these
characteristics and their impact on microfinance. The following questions are posed
during this procedure:
• Who are the financial service providers? What kind of goods and services do they
offer? What role do governments and donors play in providing underprivileged
people with financial services?
• How do existing financial sector policies, such as interest rate policies,
government mandates for sectoral credit allocation, and legal enforcement
policies, affect the provision of financial services?
• What forms of financial sector regulation exist, and are MFIs subject to these
regulations?
• What economic and social policies have an impact on financial services provision
and microentrepreneurs' ability to operate?

INTENDED LEARNING OBJECTIVES

 1. To understand the concept of microfinance.
2. To understand the meaning of microfinance and microcredit.
3. To differentiate between microcredit and microfinance.
4. To know and explain why microfinance is needed.
5. To discuss the benefits of microfinance.

The money lenders used to provide credit to the poor people in India and around the
world, at an exorbitant rate of interest since long. Gradually, this type of informal and
unorganized type of credit attained the shape of microcredit and was further
supplemented by many credit associations, cooperatives, and banks. The concept of
microfinance initiated as an introduction by Muhammad Yunus (2006) in the form of
Grameen Bank in Bangladesh. The Microfinance has been transforming rapidly in the
broader sense to include savings, credits, insurance, and funds transfer which has
assumed the shape of a revolution in the rural finance. Hence, understanding the
Microcredit and Microfinance is very important. The year 2005 was declared “The UN
Year of Microcredit” by the United Nations. Mr. Mohammad Yunus and Grameen Bank
Bangladesh were given Noble Peace Prize in the year 2006 for their efforts to create
economic and social development below through microfinance.

INITIATION OF MICROCREDIT

The money lenders, who used to provide small amount of loans to the poor and needy
people of India and around the world, are the oldest informal and unorganized form of
microcredit. The interest rate charged by them is so high that the poor people remain in
their clutches and face vicious cycle of poverty. Further they provide loan at their own
stipulated terms. Gradually, Rotating Saving and Credit Associations (ROSCAs) based
on informal understanding among friends and relatives emerged, where in interest and
costs are comparatively low but the social costs and other obligations are considerable.
These associations pool the savings of friends, relatives, near relatives and neighbors in
a systematic way and extend credit to the poor and needy families. In India ROSCAs
exist in the form of commercial chit funds. The cooperatives emerged as group type
institutions with formal constitution and legal status to some extent, which pooled the
rural poor savings and provided low amount of credit to the needy people.

Muhammad Yunus (2006), Nobel Prize winner, introduced the concept of microfinance
in Bangladesh in the form of Grameen Bank. In India, NABARD initiated the concept of
microfinance as per this idea and established link between Self Help Group (SHGs),
Non-Government Organizations (NGOs) and Banks. The SHGs are formed and nurtured
by NGOs. On attaining maturity, the SHGs get credit from banks and extend to
members. By 2006 in India more than 22 lakh SHGs were financed by Commercial
Banks, RRBs and Cooperative Banks. The microfinance movement has multiplied and
large number of SHGs, NGOs, Microfinance Institutions (MFIs), and Non-Banking
Financial Companies (NBFCs) has emerged to provide microfinance to the poor and
needy rural people. Thus, the microfinance has emerged as a movement and established
an industry.

The Microcredit is the provision of small loans to the poor people at low interest rate for
general purpose and productive activities like agriculture and allied activities, artisans
and handicraft, small business, and self-employment activities in rural, semi urban, and
urban area. The loans extended by the Banks to the Self-Help Groups (SHG) for onward
lending to members constitute the micro credit.

MICROFINANCE

Microfinance refers to the provision of affordable financial services such as small loans,
small savings, micro insurance, and funds transfer facilities extended to socially and
economically poor and disadvantaged segments of the society to enable them to increase
their income levels and improve standard of living. The main aim of microfinance is to
provide small loans to poor people particularly living below poverty line, who are not
able to raise loan for productive purposes from other sources and to improve their
standard of living by increasing their earning and saving covering associated risks.

Microfinance is universally recognized as a just and sustainable solution in alleviating

the universal widespread poverty by financing the poor people for carrying out viable
and productive activities and projects thereby generating economic surplus and hence
encouraging small savings for investments. The poor people need minimum financial
services. They need to open saving bank account in the bank to keep and multiply their
small savings by carrying out productive activities and getting small loans from banks to
purchase the assets and increase the level of their activities. In order to cover the life and
activities risks, they require micro insurance facilities. They also require funds deposit
and transfer facilities at their nearby places. In order to improve the quality and earning,
they need some basic training facilities. The provision of these minimum financial
services is covered in microfinance.

Thus, Microfinance refers to the movement in the entire world where in low-income
households have some access to the basic affordable financial services from banks or
financial institutions to finance their productive economic activities, create assets,
generate income after meeting expenses to save some net surplus and to protect their life
and activities against various hazards and risks.

According to International Labor Organization, “Microfinance is an economic

development approach that involves providing financial services through institutions to
low-income clients” Microfinance has been defined by the National Microfinance
Taskforce, 1999 in India as “Provision of thrift, credit and other financial services and
products of very small amounts to the poor in rural, semi urban and urban areas for
enabling them to raise their income levels and improve living standards.”
The poor people do not have access to capital which is required to start and grow their
economic activities. Microfinance is the provision of basic financial services like small
loans, small savings, funds transfer and micro insurance. With these services, some non-
financial services like business and activity training are required. By carrying out some
economic activities, they can earn income and can afford food, clean water, proper
shelter, education for their children and necessary health services.

DIFFERENCE BETWEEN MICROCREDIT AND MICROFINANCE

Micro credit refers to very small loans for poor people with little or no collateral security
provided by legally registered institutions like MFIs and Banks. Microfinance refers to
micro credit, small savings, insurance, and money transfers of poor and low-income
people. Microfinance is a broad category of financial services which includes micro
credit also. Micro credit is the provision of credit services to the poor people and is a
part of Microfinance. Micro credit consists of providing a financial service, i.e., micro
credit. Micro finance is the provision of financial services like savings, micro credit,
micro insurance, and funds transfer.

WHY IS MICROFINANCE NEEDED?

The banks have been more or less hesitant in providing microfinance to the poor people
with little or no cash income as they incur substantial amount to manage the borrower’s
accounts e.g. pre sanction, assessment, disbursement of loans, inspection follow-up,
recovery of loans, handling of accounts and hardly cover break-even point. The poor
people have no or few assets to offer as collateral security for the loans to the banks.
Thus, bank fear having little recourse against the defaulting borrowers.

The majority of the poor people does not have saving bank account in the bank and bank
need proper identity and address proof before providing microcredit to them. The lack of
knowledge, initiatives and collateral securities are the hindrances in getting the credit
from banks. The people need microfinance to carry out their economic activities in
commercial manner.

Microfinance is needed for the economic growth and transformation of the nation.
Microfinance is needed to eradicate poverty and record development of the nation.
Microfinance is needed to meet the life cycle needs, emergency needs and investment
needs of the people. Microfinance is needed for economic and social up liftment of the
people. Microfinance is needed for women empowerment through development.

ROLE OF MICROFINANCE

• Microfinance provides finance to the poor people for carrying out their economic
activities and helps them to meet the basic needs of life.
• Microfinance helps the poor people to increase their income, savings, and standard
of living.
• Microfinance provides employment to the poor people by providing self-
employment opportunities in various sectors and activities.
• Microfinance protects the poor people against the risks by providing life insurance
and assets insurance.
• Microfinance helps in alleviating poverty by providing affordable financial
services.
• Microfinance helps in increasing economic growth and development in the
country.
• Microfinance promotes gender equity by supporting women empowerment and
their economic participation and hence improving well-being of the poor
households.
• Microfinance provides improvements in household economic welfare and
enterprise stability and growth.
• Micro finance helps in increasing savings, investments, and developments.
• Micro finance provides employment opportunities to unemployed people and full
employment to the under employed people.

CHARACTERISTICS OF MICROFINANCE CLIENTS

• Microfinance clients are generally poor people living in poverty.

• Microfinance clients are generally unaware of the various schemes and products
which are available in the banks for the poor clients.
• Microfinance clients generally do not have easy access to finance for their
activities and most of them do not have saving bank accounts with banks.
• Microfinance clients find it difficult to provide collateral security, margin, balance
 sheets and profit and loss accounts in the banks.
• Microfinance clients cannot afford higher rates of interest and various charges
levied by banks.

BENEFITS OF MICROFINANCE

Microfinance aims at the removal of poverty, empowering the poor, mostly women to
start their own economic activities, earn money and achieve financial independence. The
recent studies also show that the recovery in microfinance is as high as 97% which
facilitates cycling of banks funds for the productive purposes.

Generally, the loan under microfinance is given without any collateral security. Thus,
the poor are in a position to get a loan and come out of the vicious cycle of poverty.
Microfinance promotes gender equality and empowers women by providing them
finance for carrying out economic productive activities. Microfinance helps in creating
long-term financial independence in the backward and poverty-ridden areas.

EXERCISES

1. Define and explain Microcredit?

2. Define and explain Microfinance?
3. Differentiate between Microcredit and Microfinance?
4. Why is Microfinance needed?
5. What is the role of Microfinance?
6. What are the general characteristics of Microfinance clients?
7. What are the benefits of Microfinance?
8. How micro credit got initiated?

REFERENCE:

Rana, O. and Raj, H. 2016. Microfinance. Himalaya Publishing House Pvt. Ltd.,
 MODULE 2
The Target Market and Impact
Analysis
➢ Group of potential clients who share certain characteristics, tend to behave in
similar ways and are likely to be attracted to a specific combination of products
and services.
➢ Can be identified by the characteristics of the clients (poverty level, gender,
ethnicity, caste, religion, etc)
Objectives of the Microfinance Institution
1. To reduce poverty
2. To empower women or other disadvantaged population groups
3. To create employment
4. To help existing businesses grow or diversify their activities
5. To encourage the development of new business
6. To create employment and income opportunities through the creation and
expansion of microenterprises
7. To increase the productivity and incomes of vulnerable groups, especially
women and the poor
8. To reduce rural families’ dependence on drought-prone crops through
diversification of their income-generating activities.
Direct and Indirect Targeting
Direct Targeting generally refers to the allocation of a specific amount of funds
to provide credit to a particular sector of the economy or population.
- Leads to credit diversion and low repayment.
Indirect Targeting means that products and services are designed for and aimed
at people who are beyond the normal frontiers, instead of mandating specific funds to a
particular group who fit a narrowly defined people
The Importance of Adequate Cash Flow and the Capacity to Service Debt
Debt capacity is an important consideration in determining the demand for
financial services. When identifying their target market, MFIs must consider clients’
and potential clients’ cash flow as well as their ability to repay loans. Pay attention to
the client’s debt capacity rather than the clients credit need.
Minimal Equity Requirement
➢ MFIs should consider clients’ ability to contribute a minimum amount of equity
➢ “People care about an asset if they have worked for it or own it”.
➢ MFIs need to monitor where their clients are accessing the capital for this
minimal equity contribution
Moral Hazard
Defined as “the incentive by someone (an agent) who holds an asset belonging
to another person (the principal) to endanger the value of that asset because the agent
bears less than the full consequence of any loss”. The best the MFI can do is to ensure
that the cash flow and debt capacity of the borrower are sufficient to service the debt.
Market size
MFIs should estimate the size of the market for microenterprises that can benefit
from financial services. Since there are costs involved in starting the delivery of financial
services in each area, it is important to know:
■ What kind of financial service will both benefit households or enterprises and have a
high likelihood of good repayment to the lender?
■ How much effective demand for the product(s) will there be initially, and how
expandable will that market be?
Identifying the Target Market
Understanding the characteristics of the target market helps MFIs design
products and services that attract different groups. The target market for MFIs generally
takes into consideration a combination of two factors:
■ Characteristics of the population group, including the level of poverty
■ The type of microenterprises being financed
Characteristics of the Population Group
Characteristics of the population group consider various socioeconomic characteristics,
including gender, poverty level, geographic focus, and ethnicity, caste, and religion. MFI
needs to understand the level of literacy (including financial literacy) of its client base to
design appropriate interventions.
I. Focusing on Female Clients
The objective of many MFIs is to empower women by increasing their economic
position in society. Women entrepreneurs have attracted special interest from MFIs
because they almost always make up the poorest segments of society; they are generally
responsible for child-rearing (including education, health, and nutrition); and they often
have fewer economic opportunities than men.
[Link] LEVEL OF POVERTY
One of the most important studies on whether micro-finance is appropriate for the
poorest of the poor is that by Hulme and Mosley in their book Finance against
Poverty.
III. GEOGRAPHIC FOCUS
Advantages - Urban Areas
>Lower transaction costs (shorter distances) for clients
> Greater chance that clients will be literate
>Potential higher chance of repayment, since interactions with clients can be more frequent
>Possible leveraging through relationships with formal financial institutions, since
urban clients may be physically closer to formal sector banks and more comfortable
with visiting banks
> More developed local infrastructure and more varied markets
Kenyan chikola system- a form of village rotating savings and credit system
-Kenya Rural Enterprise Programme (K-REP)
> established in 1984 as a development NGO that provides credit for on-
lending and technical assistance to other NGOs
> lends indirectly through NGOs and directly to groups that would at would
otherwise find it extremely difficult to access credit from commercial banks and other
formal financial intermediaries.
Disadvantages - Rural Areas
>There may be a long history of poorly designed rural credit programs (with subsidized credit,
no savings, mobilization, or credit tied to specific activities or purchases)
> There may be a less diversified economic base.
>Covariance risk can be significant.
>There may be no branches of formal financial institutions in the area.
>It may be more difficult to reach the minimum scale required to break even
>There is likely to be a poorly developed infrastructure and a more dispersed population.
IV. ETHNICITY, CASTE, RELIGION
For local MFI, a multitude of dialects has the important effects:
>All staff have to be hired locally, taking into consideration their ability to master
several dialects.
>Training activities and documents for villagers on bank management have to be
adapted into several dialects
> Networking among village banks involves many translations
TYPES OF MICROENTERPRISES
1. Existing or Start-Up Microenterprises
Working Capital- is the most common constraint identified by entrepreneurs of existing
microenterprises.
 LEVEL OF BUSINESS DEVELOPMENT
The level of business development is another consideration when identifying the types of
microenterprises to which an MFI wishes to provide financial services. This is closely
linked with the level of poverty existing in a potential target market.

3 Levels of Business Development of Microenterprises

• Unstable survivors
• Stable survivors
• Growth enterprises

Unstable Survivors
❑ These survivors are with operators who have not found other employment and
tend to have very unstable enterprises for a limited time.
❑ Unstable survivors comprise the group most difficult to provide financial
services to in a sustainable fashion; because loan sizes tend to remain small and
the risk of business failure is high.
❑ Focusing on unstable survivors as a target market can result in a great deal of
time spent with the clients just to ensure that their businesses will survive and
that they will continue to be able to make loan payments.
❑ Generally, the debt capacity of unstable survivors does not increase.
Accordingly, the MFI is limited in its attempts to reduce costs or increase
revenue, because loan sizes remain small.
Stable Survivors
❑ Stable survivors, with operators for whom the microenterprise provides a
modest but decent living while rarely growing.
❑ Stable survivors comprise the group that many MFIs focus on and for which
access to a permanent credit supply is vital.
❑ This is the group that benefits from access to financial services to meet both
production and consumption needs, while not necessarily requiring other inputs
from the MFI.
Generally, profits are low, leading to low reinvestment, low output, and a high level of
vulnerability. Profits remain low due to:
❑ The unspecialized nature of the product
❑ The lack of timely and complete market information (beyond the local market)
❑ Underdeveloped infrastructure facilities
❑ The lack of value-added services (such as packaging)
❑ The number of producers with similar products
ADVANTAGES
✓ The high poverty impact of a financial services project since these enterprises
are run by poor households
✓ High repayment, due to limited access to alternative sources of credit and the
economic, social, and financial costs of those alternatives
✓ Effective savings services, since there are rarely secure, liquid alternative forms
of savings that offer a return for the operators of these enterprises (they also
help to smooth consumption for poor households)
✓ A general willingness to work with new credit technologies (such as groups) as
an alternative to tangible collateral.
DISADVANTAGES
❖ Little or no new job creation resulting from support to these enterprises
❖ Limited growth potential or high covariance risk, because many entrepreneurs
are active in the same businesses (financing them may create excess
competition, meaning that the loan portfolio has to grow by increasing the
number of clients rather than increasing loan amounts to good clients)
❖ Difficulty in mobilizing long-term savings, since households are accustomed to
seasonal savings build-up and liquidation cycles.

Growth Enterprises
❑ Businesses that have the potential to grow and become genuinely dynamic small
enterprises.
❑ Growth enterprises are often the focus of MFIs whose objective is job creation
and whose desire is to move micro-entrepreneurs from the informal sector to a
progressively more formal environment.
❑ Most have both production and risk-taking experience, keep minimal
accounting records, and usually do not pay taxes. In addition, they often have
little or no formal management experience.
Other similarities include:
➢ Product line and labor. Firms that produce a single product or line of products
serving a narrow range of market outlets and clients tend to use labor-intensive
production techniques and rely on family and apprentice labor.
Working capital and fixed asset management. These firms build their asset base
slowly, in an ad hoc manner. They depend largely on family credit for initial
investment capital and on informal sector loans for working capital. Cash flow
is a constant concern, and they are very sensitive to output and raw material
price changes. They often use second-hand equipment.
However, selecting growth-oriented microenterprises can require a more involved
approach on the part of the MFI. Growth-oriented businesses may need some or all of
the following services:
• Assistance in choosing new product lines and value-added services
• Working capital and sometimes longer-term investment credit
• Accounting systems to track costs

• Marketing advice to help find new markets.

TYPE OF BUSINESS ACTIVITY

Enterprises can generally be divided into three primary sectors:
▪ production
▪ services
▪ agriculture
Each sector has its own specific risks and financing needs, which directly influence the
choices made by the MFI and the products and services provided.

Several advantages to focusing on one economic sector:

✓ Credit officers can focus their learning on one sector, thereby developing an
understanding of the characteristics and issues that their borrowers face.
Consequently, they may be able to provide technical assistance more easily if it
is required.
 ✓ One loan product may be sufficient for all, thereby streamlining operations and
reducing transaction costs.

Impact Analysis
❑ Analyzing the impact of microfinance interventions is especially important if
the interventions are ultimately aimed at poverty reduction (as most are).
❑ If microfinance practitioners do not make efforts to determine who is being
reached by microfinance services and how these services are affecting their
lives, it becomes difficult to justify microfinance as a tool for poverty reduction.
❑ In the most generic sense, impact analysis is any process that seeks to determine
if an intervention has had the desired outcome.
Microfinance impact analysis is the process by which one determines the effects of
microfinance as an intervention. The effects examined depend on the outcomes that
were sought (the objectives of the MFI).
Decisions about the degree, frequency, and depth of impact analysis involve
consideration of the following factors:
▪ The time and cost
▪ The disruption to the institution and its clients
▪ The way the results will be used (the fear of bad news)
All interventions can have unintended consequences. It is optional to seek and
investigate unintended impacts, but the analysis is more complete to the extent that
these unintended consequences can be illuminated.
Some likely users of microfinance impact analysis are:
▪ Microfinance practitioners
▪ Donors
▪ Policymakers
▪ Academics
Kinds of Impacts
Broadly, impacts of microfinance activities fall into three categories:
▪ Economic
▪ Socio-political or cultural
▪ Personal or psychological

ECONOMIC IMPACTS

Economic impacts can be at the level of the economy itself. A large MFI reaching
hundreds of thousands of clients may expect or aim at impact in terms of changes in
economic growth in a region or sector.
 • One MFI may seek outcomes at the level of the enterprise.
• Another may seek net gains in the income within a subsector of the informal economy
• Another may seek impact in terms of aggregate accumulation of wealth at the
level of the community or household.
• Another may seek positive impacts in terms of income or economic resource
“protection”

SOCIOPOLITICAL OR CULTURAL IMPACTS.

An MFI may seek a shift in the political-economic status of a particular subsector.
• A project aimed at credit for tricycle rickshaw drivers may hope that the drivers’
increased business will enable them to move collectively to formal status, either
by forming an association or by being able to change policy in their favor.
• An MFI in a remote rural area may expect to help shift rural people from barter
to a monetarized economy.
• Another may hope for changes in power (and status) relationships

• Another may seek, as a primary impact, the redistribution of assets (and power or
decision-making) at the household level.
• Another may seek changes in children’s nutrition or education as the result of a
microfinance activity aimed at their mothers.
PERSONAL OR PSYCHOLOGICAL IMPACTS
▪ Microfinance can have impact on the borrower’s sense of self.
▪ These impacts are the other half of empowerment effects. The first half is in a
sense political—people achieve more power in the household or community as
the result of financial services. The second half is internal and has to do with the
person’s changed view of self.
What Kinds of Impacts Have We Seen with Microfinance?
• With regard to impacts at the level of microenterprises in the informal economy,
the body of evidence suggests that microenterprise credit does not result in
significant net gains in employment, but it can and does lead to increased use of
family labor.
• We can state that there is as yet no solid evidence of business growth and
transformation as the result of microenterprise credit, but there is evidence of
credit enabling enterprises to survive (remain in business) in crises.
 • The microfinance field has not yet amassed a large body of well-researched
impact analyses. In recent years there have been reviews of existing impact
studies, and these as well as other research into the nature of poverty at the
grassroots have begun to interact with the discipline of impact analysis.
The microfinance field has not yet amassed a large body of well-researched impact
analyses. In recent years there have been reviews of existing impact studies, and these as
well as other research into the nature of poverty at the grassroots have begun to interact
with the discipline of impact analysis.
For example, provide a useful distinction between three sources of poverty:
• Lack of income
• Vulnerability to income fluctuations
• Powerlessness (few choices and little control).
AT THE HOUSEHOLD LEVEL
• While many MFIs still direct credit to pre-existing informal sector
microenterprises, many others now direct credit specifically to women who are
engaged in what could be called an income-generating activity rather than a
business.
• Making households and the household economy the targets of microfinance is
increasing as research shows how important it is to reduce the economic
insecurity of poor people, not by raising their income, but by “protecting” what
little they do have and reducing their vulnerability
• A recent review of research on impact discusses the concept of the “household
economic portfolio” as the sum total of human physical and financial resources,
which is in a dynamic relationship to the sum total of household consumption,
production, and investment activities
AT THE INDIVIDUAL LEVEL
• Similarly, as the household— seen as a tiny economy in itself—became a
guiding concept in impact analysis, formal economic decision-making has
entered into economic thinking. For example, “the role of individual
preferences, resources and bargaining power in intra-household decision
making” is now recognized as important
IMPACT PROXIES
Doing impact analysis well (and therefore credibly) can be difficult and
expensive. Addressing this dilemma, there is a school of thinking that advocates certain
“proxies” for impact.
There has been an important shift from focusing on the individual firm or client of
financial services to focusing on the institutions providing services. These financial
systems approach
“Necessarily relaxes its attention to ‘impact’ in terms of measurable enterprise growth
and focuses instead on measures of increased access to financial services” -Otero and
Rhyne.
Willingness to pay is sometimes viewed as a proxy for impact. The rationale for the
willingness-to-pay test of impact is that financial services usually require clients to pay
the cost of acquiring the service in the form of interest payments and fees as well as the
transaction and opportunity cost of the time required to come to group meetings or to
deal with other aspects of the loan process.
CLIENT-ORIENTED IMPACT ANALYSIS
The other school of thought about impact analysis consists of those who believe
that attempts must be made to assess, analyze, and measure direct impacts.
Unfortunately, the dilemma of cost and the inherent difficulty of conducting such an
analysis well have been persistent problems, which have led to a general avoidance of
the task.
THE DILEMMA OF THE HUMAN SUBJECT AS A "DYNAMIC TARGET"
If an MFI wants to effect positive change in the lives of poor people, the more the
expected impact is the result of direct intervention, the more the analysis will encounter
the complexity of human dynamics.
The dynamic interaction of individual humans, their local society, and their
culture can produce surprising results and can spoil a positive impact.
CLIENT TRANSPARENCY AND HONESTY
➢ Other reasons not to report accurately, including:
➢ Embarrassment
➢ Fear of taxation
➢ Not wanting others in the community to know
➢ Wanting to impress the person asking the question
➢ Want to please the person asking the question
➢ A different way of calculating things than the questionnaire—that is, the
respondent genuinely may not know the answers to the questions.
THE VESTED INTEREST OF THE ASSESSMENT TEAM
Anyone who is paid to do something may have a concern to please the agency
paying them, especially when they are being paid to conduct an impact assessment for
the agency whose project is being evaluated.
THE ATTRIBUTION DILEMMA
Attributing an income change to the credit taken by someone requires knowing in
detail all the sources and uses of funds by the client (which in turn is related to the
fungibility issue).
HYPOTHETICAL IMPACTS IN THE ABSENCE OF SERVICES

A different facet of the attribution dilemma is the difficulty in determining how

outcomes might have been different if no intervention had been made. To determine this
requires, at the least, the establishment of baselines and control groups.
TEMPORARY IMPACTS
An additional dilemma is the question of the ultimate value of the finding.
Assume that one finds that an intervention was or appeared to be successful in raising
people’s incomes or reducing their powerlessness. Have they moved across the poverty
line?
Have the local structures in which their lives have been embedded in the past
altered in significant ways? In short, how lasting are the changes?
WHEN SHOULD IMPACT BE ADDRESSED?
The question of when to conduct an impact assessment is not just a practical
matter of cost and methodological advantage. As with the other aspects of impact, this
question also relates to each MFI’s mission and purpose.
IMPACT ASSESSMENT BEFORE INTERVENTION
If the mission contains an absolute commitment to reach directly the poorest
segment of the population (as is the case for Credit and Savings for the Hard-core Poor
Network (CASH-POR) in the Philippines) then conducting a baseline impact assessment
prior to the initiation of financial services is essential to finding out who is going to be
the main beneficiary of the loans in terms of relative wealth.
IMPACT AFTER INTERVENTION
In this approach there are often three phases: first, a baseline study establishing
some controls at the beginning of the MFI’s operations, then an interim or midterm
impact assessment, followed 18 months or 2 years later by the final assessment.
IMPACT ASSESSMENT DURING INTERVENTION
This is coming to be called “impact monitoring.” Obviously, this approach will
likely involve keeping someone on the MFI staff full-time for this purpose.
METHODS OF IMPACT ASSESSMENT
In assessing the reviews of microfinance impact studies conducted in recent
years and recalling the dilemmas, it is tempting to conclude that the number of
problems unearthed is so great that the prospects of overcoming them are slim.
However, the opposite seems to be the case. The consensus seems to be those multiple
methods (as opposed to a single method) must be used and that combining qualitative
and quantitative approaches may be the only way to overcome these dilemmas.
They recommend that control methods include:
➢ “Statistically equated control methods,” which they feel are sufficient to address
most control issues
➢ Gender, which is a critical control variable
➢ Continued efforts to control for fungibility
➢ Control methods are a function of the data available.
Among other gaps in the studies, they reviewed were:
➢ Minimal consideration as to the location of the MFI, which is a major
determinant of success.
➢ Too little attention to alternative methodologies, such as qualitative methods
and counterfactual analysis
➢ Scant notice to questionnaire concerns, such as survey fatigue and the need for
back-translation.
➢ Infrequent inclusion of issues, such as politics, favoritism, corruption,
accountability, and leakages, as part of the design.
➢ Measuring asset accumulation at the household level is an approach that is also
increasingly recommended as a focus of impact study, especially as a way to get
around the inherent difficulties in measuring income changes accurately.
Barnes (2013) identifies six approaches to measuring assets in the microenterprise
literature:
➢ Attaching a current monetary value to assets and liabilities.
➢ Specifying whether or not a specific asset is held, which may be used to discuss
the structure of the holding or other qualitative dimensions
➢ Computing the flow value from productive assets
➢ Ranking assets based on their assumed monetary value of other qualities
➢ Constructing an index that is a composite of measures
➢ Determining the meaning of the assets to the owners and the social effects of the assets.
Fundamental Characteristics of Qualitative Approaches
The most prescribed alternatives to quantitative instruments and measures of
impact fall within the fields of sociology and anthropology.
The important general characteristics of such approaches usually include the following:
Extensivity- (a continuous or regular presence among clients over time). This enables
the researcher to deepen his or her understanding of what is going on and in turn
enables trust to develop on the part of the respondent.
Structured observation- The observation part comes into play as a form of research
control. As a simple example, in asking about household assets a respondent may
mention having recently purchased a radio or mirror.
Triangulation- Triangulation involves checking data with respondents and cross-
checking with others to get different points of view of the same
phenomenon.

Open-endedness- This is the characteristic that causes some methodological distress,

because it implies that there may be no closure to the effort or that it has no
methodological rigor. In fact, the notion of open-endedness is a response (again) to
human dynamism and complexity.
Rapid rural appraisal- methods are derivative of classic sociological and
anthropological approaches in that they also involve the use of semi-structured
interviews with key informants, participant observation, and the methodological
principles of triangulation and open-endedness.
(Robert Chambers work in Carvalho and White 2017):
• Focus groups with 5 to 12 participants from similar backgrounds or situations
(these may be observants or the subjects under analysis)
• Social mapping and modeling drawn by participants (often on the ground) to
indicate which institutions and structures of their community are important in
their lives
• Seasonality maps or calendars on which communities show how various
phenomena in their lives vary over the course of a year
• Daily time-use analysis
• Participatory linkage diagramming showing chains of causality
• Venn diagrams showing the relative importance of different institutions or
individuals in the community
• Wealth ranking.
•
Fundamental Characteristics of Quantitative Approaches
✓ By definition quantitative approaches (the word “quantitative” derives from the
Latin “quantus,” meaning “of what size”) involve quanta (units) or things that
can be counted, including income, household expenditures, and wages.
✓ Quantitative approaches to microfinance impacts rely on predesigned and
pretested questionnaires. These are formal rather than unstructured, because the
responses must be comparable and easy to count. Because survey questionnaires
are structured and relatively fixed, little interactivity is likely between surveyor
and respondent.
In general, the available quantitative methods fall into three categories:
1. Experimental methods
2. Quasi-experimental methods
3. Nonexperimental methods.
Experimental methods - involve a natural or devised experiment in which some
randomly chosen group is given the “treatment” or, in development terms, the
“intervention” (here, microfinance services). The results are then compared to a
randomly selected group of controls from whom the treatment is withheld.
Quasi-experimental methods attempt to mimic the analysis of controlled experiments,
with treatment and control groups created from different people. The differences
between the treatment and control groups may be observable or unobservable due to
their nonrandom selection.

Nonexperimental methods use nonexperimental (non-random) survey data to look at

the differences in behavior between different people and relate the degree of exposure to
the treatment to variations in outcomes. The absence of a control group separates such
methods from quasi-experimental methods.
➢ Econometrics- is an analytical technique that applies statistical methods to
economic problems. Econometric techniques have been used extensively to
analyze data gathered using quasi- and nonexperimental methods.
➢ In economics, as in the physical sciences, this model is expressed in equations
describing the behavior of economic and related variables.
➢ In single-equation specification (regression analysis), the analyst selects a single
(dependent) variable (denoted as Y ) whose behavior the researcher is interested
in explaining. The investigator then identifies one or a number of (independent)
variables (denoted by X ) that have causal effects on the dependent variable.
➢
Comparisons of Quantitative and Qualitative Approaches
The qualitative approach essentially says there are multiple forms of reality and
which “reality” is in play on whose point of view one takes. The quantitative approach
essentially assumes that there is only one reality that can be counted. Whereas for data in
quantitative methods the variables (for example, food expenditure) must be countable,
in qualitative methods only the responses to questions or the number of times a
phenomenon was observed can be counted since the variables are attitudes, preferences,
and priorities. The processes by which both quantitative and qualitative methods are
implemented necessarily depend on field workers, whether employed as enumerators,
surveyors, interviewers, participant-observers, translators, or focus group facilitators.
Integrating Methodologies
Carvalho and White (2017) recommend specific types of integration such as:
• Using the quantitative survey data to select qualitative samples
Using the quantitative survey to design the interview guide for the qualitative work
• Using qualitative work to pretest the quantitative questionnaire
• Using qualitative work to explain unanticipated results from quantitative data.
The Choice of Unit of Analysis
Regardless of the unit of analysis (the individual client, the enterprise, the
household, or the community), it is important to investigate, get to know, and interview
nonusers as well as users of the financial service. Nonusers can be of two types: those
who were and ceased to be users (dropouts) and those who were never users.
THE CLIENT AS A CLIENT- this unit of analysis focuses on the individual client as
a client of the microfinance services. The main purpose of such an analysis is for market
research—to gather the clients’ perceptions of the services to improve them.

THE CLIENT AS AN INDIVIDUAL. Both quantitative and qualitative methods can

focus on the client as an individual (also called intrahousehold impact analysis when it
extends to members of the client’s household).
THE ENTERPRISE. Using the enterprise as the unit of analysis assumes that the goal
of the MFI is largely economic: a change in the overall prospects of the enterprise
(growth, greater profits, increase in production, higher sales, acquisition of a productive
asset, a general increase in competitiveness, or some evidence of business
transformation.
THE SUBSECTOR. This unit and level of analysis is rarely if ever used in
microfinance impact analysis. It is brought to the reader’s attention to recall that the
level of analysis depends on the nature of the intervention and the intended outcomes. It
is possible that a microfinance program is designed to focus on one subsector of the
economy.
THE HOUSEHOLD ECONOMIC PORTFOLIO- This approach looks at the
household, the individual, his or her economic activity, and the local society in which
he or she is embedded and traces interactions among them.

In summary, impact analysis is not easy or without real costs. At a time in microfinance
when institutional sustainability is an almost universal goal, finding ways to pay for
impact analysis poses serious challenges. However, the future of microfinance may be
at stake as a deliberate tool for poverty reduction.
 Summary
The characteristics of the target market of a microfinance institution has a great
impact in delivering the services of the firm. In choosing a target market, there are
factors need to consider such as the socio-economic characteristics of a certain market.
Having enough and accurate information of the market would help the firm to design the
products and services they offer which is suitable to the needs of clients in the market.
Another factor to consider is the capability of the market in terms of the loans. The debt
capacity of the borrower is a useful factor to know if the client is willing and able to
borrow funds that can sustain a small business and can pay the loan and interest in a
continuous basis. It is very crucial for a microfinance institution to sustain their funds
knowing that the clients are those individuals or groups who is in the lower level of
poverty which is expected to have nothing for the collateral thing. But as a
microfinance institution, they do not put up a microfinance firm without any return.
They design products and services that has minimal rules or policy to have assurance
that the clients will pay the loan amount. There is what we called minimal equity
requirement which requires the borrower to have a minimal amount that would be use in
starting the business. It is important that the startup owner of the business should
provide that amount and not rely wholly on borrowing funds from the microfinance
institution. There’s a saying that “People care about an asset if they have worked for it
or own it”, so a microfinance firm, does not give the 100 % need of the borrower. It is a
driving force for the borrower to work properly in their business to get back the money
and effort they invest in their business.
Entering into an MFI is one of a crucial part to maintain its goal in financing
aspect. To be equal in the economy of every country, there are advantages and
disadvantages that should consider in order to fulfill everyone’s` need. And also, the
level of poverty is well studied so that the MFI will know how they will adjust
processing the management. In Geographic Focus this is one of the most important
considerations for an MFI whether it will serve urban or rural clients. This affects the
development in urban and rural areas. An MFI should know how to choose the market in
urban areas and it is highly dependent on the objectives of the MFI. And if it is well
applied, many households are helped through this because they can reach those who are
in need especially the poorest of the poor. If there are advantages there has disadvantages
that should be seen so that every MFI can properly checked if it will affect their
institution. Ethnicity, Caste and Religion are discussed and it seen that there are group in
every community are not taking financial services project. And it is important to
understand those restrictions when identifying a target market so that the products and
services can be developed that take into account the limitations on some groups. In
Micro-enterprises it is important to consider the types of activities in which the target
market is active and the level of development of the enterprise being financed.
 Every enterprises vary if it is existing r start up business; unstable, stable or
growing and involved in production, commercial or service activities. By all these
topics with subtopics, we should know how to see all the capacity and the ability of
every individual when entering into an MFI. And to be on a better economy, MFI
should consider and see the importance of each household so that at the end and on the
long run of the institution, they can see the problem and easily to address it.

In doing an impact analysis there are many factors that need to consider to be
able to achieve the goal of the MFI effectively, and proxies serve as the tool to think
wisely and come up to a better decision that will help to grow the institution. Some
viewed that impact analysis are just consists of those who believe that attempts must be
made to assess, analyze and measure direct impacts but there are dilemmas that makes
the analysis differently. The client transparency and honesty must always perform
because their personality will reflect to the performance of the institution and this will
be the basis if the client have a good record and can apply to another loan. There are
also assessment team who are responsible in conducting the impact assessment which
will have an interest in the outcome of the study and thus consciously or unconsciously
may distort some responses. The attribution dilemma requires knowing all the other
events and influences that occurred while the credit intervention was undertaken and
separating them from the specific impacts of the credit and savings program.
Temporary impacts must also be considered because there are questions that need to
understand that will help to solve the issue that leads for an improvement to the
institution. In order to come up to a better assessment, it should be classified the different
approaches before, during and after intervention. In doing an impact assessment before
intervention, it should assess the main beneficiary of the loans and the financial
services. Then, during intervention this is called as impact monitoring wherein it will
likely involve keeping someone on the MFI staff full time for this purpose. Lastly, after
intervention there often three phases that will be assess for final assessment. After
knowing some considerations, it is also important to know the methods of impact
assessment where there are qualitative and quantitative approaches that may be the only
way to overcome these dilemmas.
 When collecting and analyzing data, quantitative research deals with numbers
and statistics, while qualitative research deals with words and meanings. Both are
important for gaining different kinds of knowledge. Quantitative research is expressed
in numbers and graphs. It is used to test or confirm theories and assumptions. This type
of research can be used to establish generalizable facts about a topic. Common
quantitative methods include experiments, observations recorded as numbers, and
surveys with closed-ended questions. Qualitative research Qualitative research is
expressed in words. It is used to understand concepts, thoughts or experiences. This
type of research enables you to gather in-depth insights on topics that are not well
understood. Common qualitative methods include interviews with open-ended
questions, observations described in words, and literature reviews that explore concepts
and theories. In Unit of Analysis, one of the most important ideas in a research project
is the unit of analysis. The unit of analysis is the major entity that you are analyzing in
your study. For instance, any of the following could be a unit of analysis in a study:
individuals groups artifacts (books, photos, newspapers) geographical units (town,
census tract, state) social interactions (dyadic relations, divorces, arrests). Why is it
called the ‘unit of analysis’ and not something else (like, the unit of sampling)?
Because it is the analysis you do in your study that determines what the unit is. For
instance, if you are comparing the children in two classrooms on achievement test
scores, the unit is the individual child because you have a score for each child. On the
other hand, if you are comparing the two classes on classroom climate, your unit of
analysis is the group, in this case the classroom, because you only have a classroom
climate score for the class as a whole and not for each individual student. For different
analyses in the same study, you may have different units of analysis. If you decide to
base an analysis on student scores, the individual is the unit. But you might decide to
compare average classroom performance. In this case, since the data that goes into the
analysis is the average itself (and not the individuals' scores) the unit of analysis is the
group. Even though you had data at the student level, you use aggregates in the
analysis. In many areas of social research these hierarchies of analysis units have
become particularly important and have spawned a whole area of statistical analysis
sometimes referred to as hierarchical modeling. This is true in education, for instance,
where we often compare classroom performance but collected achievement data at the
individual student level.
 MODULE 3
Products and Services
MFIs can offer their clients a variety of products and services. First and
foremost are financial services. However, due to the nature of an MFI’s target clients—
poor women and men without tangible assets, who often live in remote areas and may be
illiterate— MFIs cannot operate like most formal financial institutions.
Providing effective financial services to low-income women and men therefore
often requires social intermediation—” the process of creating social capital as a
support to sustainable financial intermediation with poor and disadvantaged groups or
individuals”
MFIs provide enterprise development services such as skills training and basic business
training (including bookkeeping, marketing, and production) or social services such as
health care, education, and literacy training.
The Systems Framework
The systems perspective is important not only because there may be a number of
different institutions involved, but also because these institutions are likely to have very
different institutional goals or “corporate missions.” Thus if a commercial bank is
involved, its goal is to build its equity and deliver a profit to its owners. In contrast,
both government agencies and nongovernmental organizations (NGOs), despite their
many differences, are service organizations rather than profitmaking institutions. Credit
and savings clients themselves, if formed as a membership organization, have their own
corporate mission: to serve its members who are both clients and owners.
Formal financial institutions and membership organizations, financial sustainability is an
essential goal. NGOs although expected to operate efficiently and to cover as much of
their costs as possible, are not expected to generate a profit.
Four broad categories of services that may be provided to microfinance clients:
1. Financial intermediation
2. Social intermediation
3. Enterprise development service
4. Social services

Microfinance Institutions—Minimalist or Integrated?

Potential Issues
 Providing financial and nonfinancial services are two distinct activities, which
may at times lead an institution to pursue conflicting objectives.
 It is often difficult for clients to differentiate “social services,” which are usually
free, from “financial services,” which must be paid for, when they are receiving
both from the same organization.
 MFIs offering many services may have difficulties identifying and controlling
the costs per service.
 Nonfinancial services are rarely financially sustainable.

Financial Intermediation
The primary role of MFIs is to provide financial intermediation. This involves the
transfer of capital or liquidity from those who have excess at a particular time to those
who are short at that same time.
Two key imperatives that must be considered when providing financial services are:
 To respond effectively to the demand and preferences of clients
 To design products that are simple and can be easily understood by the clients
and easily managed by the MFI

Credit is borrowed funds with specified terms for repayment. When there are
insufficient accumulated savings to finance a business and when the return on borrowed
funds exceeds the interest rate charged on the loan, it makes sense to borrow rather than
postpone the business activity until sufficient savings can be accumulated, assuming the
capacity to service the debt exists.
MFIs can be sustainable providing they have enough funds to continue
operating in the long term. These funds can be obtained solely through operational
revenue or through a combination of grants and operating revenue. As microfinance
develops, clear principles are being established that lead to financially viable lending
(box 3.1).

Box 3.1 Principles of Financially Viable Lending to Poor Entrepreneurs

Principle 1. Offer services that fit the preferences of poor entrepreneurs. These services
might include:
■ Short loan terms.
■ Repeat loans.
■ Relatively unrestricted uses.
■ Very small loans, appropriate for meeting the day-to-day financial requirements of
businesses.
■ A customer-friendly approach.
Principle 2. Streamline operations to reduce unit
costs. Standardize the lending process.
Principle 3. Motivate clients to repay loans.
■ Joint liability groups.
■ Incentives
Principle 4. Charge full-cost interest rates and fees.

Methods of credit delivery can generally be divided into the two broad
categories of individual and group approaches, based on how the MFI delivers and
guarantees its loans.
■ Individual loans are delivered to individuals based on their ability to provide the
MFI with assurances of repayment and some level of security.
■ Group-based approaches make loans to groups—that is, either to individuals who are
members of a group and guarantee each other’s loans or to groups that then sub loan to
their members.

INDIVIDUAL LENDING.
Formal financial institutions base lending decisions on business and client
characteristics, including cash flow, debt capacity, historical financial results, collateral,
and character.
Informal sector lenders approve loans based on the personal knowledge of the borrowers
rather than on sophisticated feasibility analysis, and they use informal collateral sources.

Characteristics of individual lending models include:

 The guarantee of loans by some form of collateral (defined less stringently than
by formal enders) or a cosigner (a person who agrees to be legally responsible for
the loan but who usually has not received a loan of her or his own from the MFI).
 The screening of potential clients by credit checks and character references.
 The tailoring of the loan size and term to business needs.
 The frequent increase over time of the loan size and term.
 Efforts by the staff to develop close relationships with clients so that each client
represents a significant investment of staff time and energy

GROUP-BASED LENDING.
 Group-based lending involves the formation of groups of people who have a
common wish to access financial services.

Advantages of Group-based Lending:

 Use of peer pressure as a substitute for collateral
 The financial and social grouping elicits several types of group dynamics that may
increase repayment rates
 It may reduce certain institutional transaction costs

Disadvantages of Group-based Lending:

 worse repayment rates in years with some type of crisis
 training costs tend to be quite high, and no individual borrower-bank relationship
is established over time.
 the inherent instability of group lending in risky environments
(box 3.5). client transaction costs are quite high

MFIs offer both products and services to its client which are the unfortunate
people or household. They offer four broad categories of services to be access by these
microfinance clients which are divided into two approaches; the Minimalist and
Integrated [Link] minimalist approach includes the financial services such as
Financial Intermediation and Social Intermediation while Integrated Approach includes
the financial and non-financial services that includes the financial intermediation, social
intermediation, enterprise development service and social services; Financial
intermediation are the one who can guarantee an immediate capital/loan for those who
are in need of money which includes working capital, fixed asset loans, savings and
insurance. Social intermediation is the method used to create social capital to sustain the
utilization of financial intermediation in corporate to group formation, leadership
training, and cooperative learning. Enterprise development service offers marketing,
business training, production training and subsector analysis to their clients. And lastly,
social services which is composed of education, health and nutrition, and literacy
training. Credit is when the creditors borrowed money to the lenders by which the
lenders give a specific time and date for the repayment details of the loan and also give
the creditor an interest charge for the loan. These credits may include short loan terms,
repeat loans, relatively unrestricted uses, very small loans that was appropriate for
meeting the day-to-day financial requirements of businesses, and a customer-friendly
approach. A creditor/s may guarantee a credit in terms of individual loans or group-
based. In individual lending the creditor were required to give collateral to secure their
loans as it can be the payment if the creditor failed to repay the loan to the lender or the
creditor may asked for his/her cosigner who will take the full responsibility of the loan,
however, this person must not have any record of receiving loans from MFI. Whilst,
group-based lending allows a group of people with similar intentions to acquire
loans from MFI, yet, it has advantages and disadvantages to those who will acquire this
type of loan. One of the advantages of group-based lending was it may reduce certain
institutional transaction costs while the disadvantage was the creditors might encounter
worse repayment rates in years with some type of crisis.

Savings
- Savings mobilization has long been a controversial issue in microfinance.
- These developments attest to the fact that low-income clients can and do save.
- The World Bank’s “Worldwide Inventory of Microfinance Institutions” found
that many of the largest, most sustainable institutions in microfinance rely
heavily on savings mobilization.
- “Statistical analysis of the surveyed institutions reveals a positive correlation
between the amount of deposits mobilized and the average growth in per capita
GNP of the country
The Role of Groups in Financial Intermediaries
Guidelines for effective use of groups:
▪ Groups are more effective if they are small and homogeneous.
▪ Imposing group penalties and incentives (such as no access to further loans
while an individual is in default) improves loan performance.
▪ Loan sizes that increase sequentially appear to allow groups to screen out bad risks.
▪ Staggered disbursements to group members can be based on the repayment
performance of other members.
Possible advantages of using groups:
▪ Economies of scale (a large clientele with minimal increases in operating costs).
▪ Economies of scope (an increased capacity to deliver multiple services through
the same group mechanism).
▪ Mitigation of information asymmetry related to potential borrowers and savers
through the group’s knowledge of individual members.
▪ Reduction of moral hazard risks due to group monitoring and peer pressure.
▪ Substitution of joint liability for individual collateral.
▪ Improved loan collection through screening and selecting, peer pressure, and
joint liability, especially if group penalties and incentives are incorporated in the
long terms.
 ▪ Improved savings mobilization, especially if incentives are incorporated in a group
scheme.
▪ Lower administrative costs (selection, screening, and loan collection) once the
initial investments as made in establishing and educating the groups.
Risks associated with using groups:
▪ Poor records and lack of contract enforcement.
▪ Potential for corruption and control by a powerful leader within the group.
▪ Covariance risk due to similar production activities.
▪ Generalized repayment problems (domino effect).
▪ Limited participation by women members in mixed-gender groups.
▪ High up-front costs (especially time) informing viable groups.
▪ Potential weakening of group if group leader departs.
▪ Increased transaction costs to borrowers (time for meetings and some voluntary
management functions).
Compulsory Savings
Compulsory savings differ substantially from voluntary savings.
For the most part, compulsory savings can be considered part of a loan product
rather than an actual savings product, since they are so closely tied to receiving
and repaying loans.
Compulsory saving is useful to:
▪ Demonstrate the value of savings practices to borrowers
▪ Serve as an additional guarantee mechanism to ensure the repayment of loans
▪ Demonstrate the ability of clients to manage cash flow and make periodic
contributions (important for loan repayment)
▪ Help to build up the asset base of clients.
Voluntary Savings
Voluntary savings services are provided to both borrowers and borrowers who
can deposit or withdraw according to their needs.
Microfinance clients may not feel comfortable putting voluntary savings in
compulsory savings accounts or even in other accounts with the same MFI.
There are three conditions that must exist for an MFI to consider mobilizing voluntary
savings services.
An enabling environment, including appropriate legal and regulatory
frameworks, areasonable level of political stability, and suitable demographic
conditions.
Adequate and effective supervisory capabilities to protect depositors
Consistently good management of the MFI’s funds.
Requirements for effective voluntary savings mobilization include:
▪ A high level of client confidence in the institution (a sense of safety)
▪ A positive real deposit interest rate
▪ Flexibility and diversity of savings instruments
▪ Security
▪ Easy access to deposits for clients
▪ Easy access to the MFI
▪ MFI staff incentives linked to savings
mobilization. Insurance
- MFI’s are beginning to experiment with other financial products and services
such as insurance, credit cards, and payment services.
- Insurance is a product that will likely be offered more extensively in the future
by MFI’s. Credit Cards and Smart Cards
Credit Cards – these cards allow borrowers to access a line of credit if and when they need it.
Smart Cards – smart cards contain a memory chip that contains information about a
client’s available line of credit with a lending institution.
Payment Services
- In traditional banks payment services include check cashing and check writing
privileges for customers who maintain deposits

Social Intermediation

❑ For individuals whose social and economic disadvantages place them “beyond
the frontier” of formal finance, successful financial intermediation is often
accompanied by social intermediation.
 ❑ Social intermediation can thus be understood as the process of building the
human and social capital required for sustainable financial intermediation with
the poor

❑ Social intermediation prepares marginalized groups or individuals to enter into

solid business relationships with MFIs
Group social intermediation
- defined as the effort to build the institutional capacity of groups and invest in
the human resources of their members, so that they can begin to function more
on their own with less help from outside.
- a range of capacity-building that can take place with social intermediation.
- This aspect of social intermediation mostly involves training group members in
participatory management, accounting, and basic financial management skills
and helping groups to establish a good record-keeping system.

Enterprise Development Service

Enterprise development services include a wide range of nonfinancial interventions,

including:
■ Marketing and technology services ■ Business training
■ Production training ■ Subsector analysis and interventions
Enterprise development service programs could be divided into:
■ Enterprise formation programs, offering training in sector-specific skills such as
weaving as well as training for persons who might start up such businesses.
■ Enterprise transformation programs, providing technical assistance, training, and
technology to help existing microenterprises make a quantitative and qualitative leap in
terms of scale of production and marketing.

An additional distinction is between direct and indirect services, which has to do with
the interaction between the provider of services and the enterprises
 ▪ Direct services are those that bring the client in contact with the provider.
▪ Indirect services are those that benefit the client without such direct contact, as
in policy- level interventions.
Enterprise development services projects do not generally involve money as a
commodity, but rather the transfer of knowledge in the form of skills, information,
research, and analysis. The returns to the client as a result of this new knowledge are
difficult to assess. Likewise, because the client cannot measure the value of
“knowledge” at the “point of purchase,” paying its full cost to the provider is rarely
possible.

Certain studies have questioned the value of enterprise development services in the
following areas:
■ Impact.
Some studies have shown that in many cases there is little difference in profits and
efficiency between those microenterprises that received credit alone and those that
received integrated enterprise development services and credit package.
■ Cost and impact
These [enterprise development service] programs tend to fall into one of two patterns.
Either they have provided generic services to large numbers, with little impact on the
businesses; or they have provided closely tailored assistance to a few enterprises, at
high cost per beneficiary.”

■ Outreach
A common complaint about enterprise development services is that women’s access to
these services is limited.

Social Services

Individual Lending

-defined as the provision of credit to individuals who are not members of a group that is
jointly responsible for loan repayment. -Individual lending requires frequent and close
contact with individual clients to provide credit products tailored to the specific needs of
the business. It is most successful for larger, urban-based, production-oriented
businesses and for clients who have some form of collateral or a willing cosigner.
METHOD. -Clients are individuals working in the informal sector who need working
capital and credit for fixed assets. - Credit officers usually work with a relatively small
number of clients (between 60 and 140) and develop close relationships with them over
the years, often providing minimal technical assistance.

Detailed financial analysis and projections are often included with the loan application.
The amount and terms are negotiated with the client and the credit officer’s supervisor
or other credit officers. Documentation is required, including a loan contract; details
regarding the clients references; if applicable, a form signed by the cosigner and his or
her personal information; and legal deeds to assets being pledged and credit history.

Credit officers are often recruited from the community so that they can base their
analysis on their knowledge of the client’s creditworthiness (character-based lending).

PRODUCTS. -Loan sizes can vary from US$100 to US$3,000 with terms between six
months and five years. -Savings may or may not be provided depending on the
institutional structure of the MFI. Training and technical assistance may be provided by
credit officers; sometimes training is provided on a per-fee-basis or is mandatory.
Example: Green Bank of Caraga (Philippipnes)

APPROPRIATE CLIENTS. Clients are urban enterprises or small farmers, including

both men and women, and may be medium-income small businesses, microbusinesses,
and production enterprises.

Grameen Solidarity Group Lending

-This lending model was developed by the Grameen Bank of Bangladesh to serve rural,
landless women wishing to finance income-generating activities. -Peer groups of 5
unrelated members are self-formed and incorporated into village “centers” of up to
eight peer groups. -Attendance at weekly meetings and weekly savings contributions,
group fund contributions, and insurance payments are mandatory. -Savings must be
contributed for four to eight weeks prior to receiving a loan and must continue for the
duration of the loan term. The group fund is managed by the group and may be lent out
within the group.

Group members mutually guarantee each other’s loans and are held legally responsible
for repayment by other members.
No further loans are available if all members do not repay their loans on time.
No collateral is required. Mandatory weekly meetings include self-esteem building activities
and discipline enforcement.
Loans are made to individuals within the group by the local credit officer at the weekly
meetings.

PRODUCTS.
Credit is for six months to one year and payments are made weekly. Loan amounts are
usually from US$100 to US$300. Interest rates are 20 percent a year.
"Savings are compulsory."

SIGNIFICANT EXAMPLES. These include Grameen Bank and Bangladesh Rural

Advancement Committee in Bangladesh; Tulay sa Pag-Unlad, Inc. and Project
Dungganon in the Philippines; Sahel Action in Burkina Faso; and Vietnam Women’s
Union.

APPROPRIATE CLIENTELE. Clients are from rural or urban (densely populated)

areas and are usually (although not exclusively) women from low-income groups
(means tests are applied to ensure outreach to the very poor) pursuing income-
generating activities.

Latin American Solidarity Group Lending

This model makes loans to individual members in groups of four to seven. The
members cross- guarantee each other’s loans to replace traditional collateral. Clients are
commonly female market vendors who receive very small, short-term working capital
loans. This model was developed by ACCION International in Latin America and has
been adapted by many MFIs.

METHOD.
Customers are typically informal sector microbusinesses, such as merchants or traders
who need small amounts of working capital. Group members collectively guarantee
loan repayment, and access to subsequent loans is dependent on successful repayment
by all group members.
Payments: weekly at the program office. The model also incorporates minimal technical
assistance to the borrowers, such as training and organization building. Credit officers
generally work with between 200 and 400 clients and do not normally get to know their
clients very well.
Loan disbursement is made to the group leader at the branch office, who immediately
distributes to each individual member. Credit officers make brief, occasional visits to
individual clients.

Group members normally receive equal loan amounts, with some flexibility provided
for subsequent loans. Loan amounts and terms are gradually increased once clients
demonstrate the ability to take on larger amounts of debt. Loan applications are simple
and are reviewed.

Savings are usually required but are often deducted from the loan amount at the time of
disbursement rather than requiring the clients to save prior to receiving a loan. Savings
serve primarily as a compensating balance, guaranteeing a portion of the loan amount.

PRODUCTS. Initial loan amounts are generally between US$100 and US$200.
Subsequent loans have no upper limit.
Interest rates are often quite high and service fees are also charged. Savings are usually
required as a portion of the loan; some institutions encourage establishing intragroup
emergency funds to serve as a safety net. Very few voluntary savings products are
offered.

SIGNIFICANT EXAMPLES. These include ACCION affiliates: PRODEM, BancoS ol

Bolivia; Asociación Grupos Solidarios de Colombia; and Genesis and PROSEM in
Guatemala

APPROPRIATE CLIENTELE. Clients are mostly urban and include both men and
women who have small to medium incomes (microbusinesses, merchants, or traders).

Villa Banking
-is a community-managed credit and savings associations established to provide access to
financial services in rural areas, build a community self-help group, and help members
accumulate savings. The model was developed in the mid1980s by the Foundation for
International Community Assistance (FINCA).
-30-50 people (mostly women)
Membership is based on self-selection. The bank is financed by internal mobilization of
members’ funds as well as loans provided by the MFI.

A village bank consists of its membership and a management committee, which

receives training from the sponsoring MFI. The sponsoring MFI lends seed capital
(external account) to the bank, which then lends on the money to its members. All
members sign the loan agreement to offer a collective guarantee.

The loan amount to the village bank is based on an aggregate of all individual
members’ loan requests. Although the amount varies between countries, first loans are
typically short term (four to six months) and are small amounts ($50), to be repaid in
weekly installments

PRODUCTS.
Members’ savings are tied to loan amounts and are used to finance new loans or
collective income generating activities. No interest is paid on savings. However,
members receive a share from the bank’s relending or investment profits.

The dividend distributed is directly proportional to the amount of savings each

individual has contributed to the bank. Loans have commercial rates of interest (1 to 3
percent per month) and higher rates if from an internal account. Some banks have
broadened service delivery to include education an about agricultural innovations,
nutrition, and health.

SIGNIFICANT EXAMPLES
Catholic Relief Services works through local NGOs. Freedom From Hunger in West
Africa works directly with credit unions in order to help them increase their
membership among women. Its clients graduate to the credit union.

APPROPRIATE CLIENTELE.
Clients are usually from rural or sparsely populated but sufficiently cohesive areas.
- very low incomes but with savings capacity, and are predominantly women (although the
program is also adequate for men or mixed groups)
Self-Reliant Village Banks (Savings and Loans Associations)

are established and managed by rural village communities. - They differ from village
banks in that they cater to the needs of the village as a whole, not just a group of 30 to
50 people. - This model was developed by a French NGO, the Centre for International
Development and Research, in the mid1980s.

Self-Reliant Village Banks (Savings and Loans Associations)

METHOD. The supporting program identifies villages where social cohesion is strong
and the desire to set up a village bank is clearly expressed. The villagers—men and
women together— determine the organization and rules of their bank. They elect a
management and credit committee and two or three managers. Self-reliant village banks
mobilize savings and extend short-term loans to villagers on an individual basis. The
sponsoring program does not provide lines of credit. The bank must rely on its savings
mobilization.

After a year or two the village banks build up an informal network or association in
which they discuss current issues and try to solve their difficulties. The association acts
as intermediary and negotiates lines of credit with local banks, usually an agriculture
development bank. This links the village banks to the formal financial sector. Because
management is highly decentralized, central services are limited to internal control and
auditing, specific training, and representation. These services are paid for by the village
banks, which guarantees the financial sustainability of the model.

PRODUCTS.

-include savings, current accounts, and term deposits.

-Loans are short-term, working-capital loans. There is no direct link between loan
amounts and a member’s savings capacity;

interest rates are set by each village according to its experience with traditional savings
and loans associations. The more remote the area, the higher the interest rate tends to
be, because the opportunity cost of money is high.

Loans are paid in one installment. Loans are individual and collateral is necessary, but
above all it is village trust and social pressure that ensure high repayment rates.
Management committees, managers, and members all receive extensive training. Some
programs also provide technical assistance to microentrepreneurs who are starting up a
business.

APPROPRIATE CLIENTELE. Clients are in rural areas and include both men and
women with low to medium incomes and some savings capacity
Matching Enterprise Development Services to Demand

Designing appropriate enterprise development services requires an

understanding of the many systems (cultural, legal, political, macroeconomic, local,
marketplace) within which microenterprises operate.
Micro-entrepreneurs and small business operators may be less aware than their
larger counterparts are of the degree to which those systems can impinge upon their
business activity.

The Entrepreneur’s Context

1. The Business Operator

❖ The enterprise owner’s self is the first context in which he or she operates. At
this level, constraints on the success of the business often have to do with
intangibles such as the presence of or lack of confidence, tenacity,
resourcefulness, ambition, adaptability, and the capacity to learn.

2. The Business
❖ This is where all operations take place in the enterprise, from buying inputs to
making and selling the product or service. At this level the problems and
constraints encountered begin to have as much to do with forces external to the
operator as they do with the operator’s knowledge.

3. The Sub-Sector
❖ It is identified by its final product and includes all firms engaged in the supply
of raw materials, production, and distribution of the product.
❖ The Sub-Sector Approach emphasizes:
✓ Market access
✓ Leverage
✓ Releasing constraints
❖ Common Constraints in the Sub-sector Level:
✓ Rising competition, as low barriers to entry allow new microenterprises
into the marketplace
✓ Space for the market’s physical infrastructure, including warehousing
✓ The imposition of fees or solicitation of bribes by local authorities
✓ Transport availability, reliability, and cost
✓ Input availability, if a commodity that the enterprise needs for
production is not available regularly
 ✓ Lack of appropriate technology
✓ Limits (permanent, cyclical, seasonal) in customer purchasing power
✓ Lack of product diversity
✓ Dominance by middlemen.
❖ Possible Solutions:
A. Expansion of the Range of Suppliers and Customers
B. Networking and Entrepreneurs Clubs
✓ Sharing information on markets or suppliers
✓ Setting up joint cooperatives
✓ Bidding on contracts together
✓ Sharing costs of holding a stand at a fair or market
✓ Reducing costs of warehousing by splitting a facility
C. Market Infrastructure Improvement

4. Beyond the Local Marketplace

❖ The last of the concentric circles surrounding the individual micro-entrepreneur
is the largest and furthest away from his or her enterprise.
❖ Here at the macro level the forces exerting constraints on the enterprise are indeed large.
❖ These can be at the country level, the regional level, and even the world trade
level. They extend beyond the marketplace and economic forces in general to
include:
✓ National social and political forces and geopolitical forces
✓ Regulatory and policy forces and constraints
✓ Macro-level market forces, such as the dynamism or weakness of other
exporters of the same commodity in other countries
✓ National and global labour market forces, including changes in migrant
labour patterns
✓ Contiguous financial sector constraints and enable
 MODULE 4
The Institution

IMPORTANCE OF INSTITUTIONS
An institution is a collection of assets-human, financial, and others-combined to perform
activities such as granting loans and taking deposits overtime. A one-time activity such
as a "project" is not an institution. Thus, by its very nature, an institution has a function
and a certain permanence.
Attributes of a Good Institution
(1) It provides services to the relevant target group.

(a) Appropriate services

(b) The scope of services
(c) Prices
(2) Its activities and offered services are not only demanded but also have some
identifiable positive impact on the lives of the customers.
(3) It is strong, financially sound, and stable (a)Stability (b)Expand its scale of (c)operations
(d)Subsidy Independent (e)Organizational Stability

THE IMPORTANCE OF PARTNER INSTITUTIONS

Partners discuss and jointly define objectives and ways of attaining them. In a
partnership, both sides have the same rights to determine what the partners can do and
want to do together "organizations seek to mutually strengthen and sustain themselves.
It (the partnership] is an empowering process, which relies on trust and confidence,
solidarity of vision and approach, and it acknowledges mutual contribution and
equality. Both partners have complementary roles, established through negotiations and
subject to change as the partnership grows and circumstances change."
Local Institutions
It can bring to the partnership the advantage of knowing more about local circumstances:
the target group or clientele, their situation, and demand for financial services, the local
financial market, and the local laws and habits.
Foreign Partners Agencies
It can bring funding, technical assistance, and training to the partnership.
KEY CHARACTERISTICS OF A STRONG MICROFINANCE INSTITUTION
Vision
Financial services and delivery method’s Organizational structure and human resources
Administration and finance Management information system Institutional viability Outreach
and financial sustainability

Institutional Types

3 types of Institutional
 Formal Institutions
 Semi formal Institution
 Informal Provider

Formal Institutions
defined as those that are subject not only to general laws and regulations but also to
specific banking regulations and supervision.
Types of Formal Institutions

Public Development Banks

Development banks are or until quite recently have been, a special type of large,
centralized, government-owned bank. Most of them were set up with ample financial
support from foreign and international organizations. They were created to provide
financial services to strategic sectors such as agriculture or industry.

Private Development Bank

A special category of banks that exist in some developing countries. Their aim is broad
economic development directed to fill capital gaps in the productive sector that are
considered too risky by commercial standards.

Saving Banks and Postal Banks

As the name indicates, savings banks tend to emphasize savings mobilization more than
other banks. Their main strength is that they are decentralized, rooted in the local
community, and interested in serving local small business.

Commercial Banks
Formal financial institutions that focus on short- and long-term lending to establish a business

Non-Bank Financial Institution

These institutions are set up to circumvent the inability of some MFI’s to meet
commercial bank standards and requirements due to the nature of their lend

There are 12 basic principles with which banks must comply if they choose to focus
part of their operations on low-income clients

1. Ensure appropriate governance

2. Define the institutions strategies and objectives
3. Learn from the competition in the informal sector
4. Find out what services clients really want
5. Establish appropriate modes of delivery
6. Contain transaction costs
7. Cover costs with appropriate, positive on-lending interest rates
8. Customize loan terms and conditions for the target clientele
9. Monitor and maintain the quality of the asset
10. Manage and diversify risks
11. Mobilize savings resources in the market
12. Motivate staff and invest in them (with information and incentives)

Semi formal Financial Institutions

The most common types of semiformal financial institutions are financial cooperatives
and financial NGOs

Credit Unions, Saving & Loan Cooperative sand other Financial Cooperatives
There are a great many forms of cooperative financial institutions (often identified as
credit unions or savings and loan cooperatives). Such institutions play a significant role
in the provision of financial services to poor target groups.

Characteristics of financial cooperatives include:

 Clients who tend to come from low-income and lower-middle-income groups.
 Services that are almost exclusively financial in nature.
 Self-generated capital, typically without any dependence on outside funding to
cover operating costs, which are generally kept low

Financial NGO’s
Even more than with other types of institutions, a discussion of NGOs that provide
financial services has to start by emphasizing that they are indeed a very diverse group.
The general definition of an NGO is based on what it is not: neither government-related
nor profit-oriented.

NGOs can be attributed to a combination of the following factors:

 The lack of business acumen with which some NGOs are set up and operated
 Overly ambitious aspirations with regard to their social relevance
 The limited scale of their operations, which does not permit them to benefit from
elementary economies of scale
 The frequent use of donated funds or soft loans from foreign development organizations
 The influence of people who do not belong to the target group and thus are not
subject to peer pressure and are not directly hurt if the institution’s money is
eventually lost
Informal Financial Provider
Informal finance is probably much more important for the financial management of
poor households than the provision of services by formal and semiformal financial
institutions

Institutional Growth and Transformation

For the most part, MFIs are created as semiformal institutions—either as NGOs or as
some form of savings and credit cooperative. Given these institutional structures, they
are often limited by a lack of funding sources and the inability to provide additional
products.

EXPANSION WITHIN AN EXISTING STRUCTURE

*Existing structures may be most appropriate to expand their structure as they
have already their substantial capital and reserve requirements. Depending on the laws
or other regulations of a country, differs on the limitation of the MFI’s to operate.
CREATING AN APEX INSTITUTION
An apex institution is a second-tier financial intermediary. It is owned by an
external organization rather than the members. They don’t directly provide service to
microentrepreneurs; rather they are providing the MFIs to pool and access resources.
Apex Institution can:
✓ Provide for more efficient allocation of funds
✓ Conduct market and product development for the benefit of its primary institutions
✓ Offer innovative sources of funds, such as guarantee funds or access to a line
of credit from external sources
✓ Serve as a source of technical assistance for improving operations, including
the development of management information systems and training courses
✓ Act as an advocate in policy dialogue for MFIs. The experience of apex
institutions has been mixed.
Potential weaknesses of Apex Institution
➢ Vision and governance issues are more complex by how many partied
involved in the institution, the more involve, more complex
➢ The commitment to expansion may vary among the members since not all
members are the same. Same as the growth rate of each of them, since members
differs in their financial capability, it affects them.
➢ Since the cost is highly, there needs to be a constant attention to productivity
and performance
 Apex Institution may also be useful in the following situations
✓ When they are the last resort, on basis of cost. They are only used in important
and profitable situations
✓ When in seasonal lending, like the Agricultural sector since there are many farmers
tend to lend when they are going to harvest or plant new crops
✓ When retail lenders are not permitted to take deposits. Apex institutions could then
play a useful role if they added value through their terms and conditions and behaved
commercially.

CREATING A FORMAL FINANCIAL INTERMEDIARY

This approach involves the transfer of the NGO’s or cooperative’s operations to a newly created
financial intermediary, while the original institution is either phased out or continues to exist
alongside the new intermediary.
*Like the apex institution, the cost of converting an NGO or any cooperative into formal
financial intermediary is costly
*In creating a formal financial intermediary, it may be merged as one entity or constructing
another one as a branch and making the other one as the main headquarters.

There are some useful bridging mechanisms to help NGO’s or cooperatives to work their
expansion well:
✓ Overlapping directorates - a manager or any head of the organization may supervise or
direct the expansion.
✓ Cost-sharing of head office functions, branch space, insurance, and so forth - the cost of the
institution may be shared by both the main office and the new structure
✓ Joint resource mobilization, with the NGO attracting the social investment capital that the
financial intermediary may not qualify for directly - if the expanded existing structure were
still low on manpower, head office can provide required manpower to gather more potential
investments.
✓ Coordinating policies for product development, target areas, and populations - the policies
of the head office may be the same or different to the policies of the new office,
coordination of the policies may help the institution to know what is the best policies for
both offices.
 GOVERNANCE AND OWNERSHIP GOVERNANCE
Governance refers to a system of checks and balances whereby a board of
directors is established to oversee the management of the MFI.
Basic responsibilities of the board are:
o Fiduciary. The board has the responsibility to safeguard the interests of
all of the institution’s stakeholders
o Strategic. The board participates in the MFI’s long-term strategy by
critically considering the principal risks to which the organization is
exposed and approving plans presented by the management.
o Supervisory. The board delegates the authority for operations to the
management through the executive director or chief executive officer.
 o Management Development. The board supervises the selection,
evaluation, and compensation of the senior management team.
*As management systems are developed, the need for governance arises to ensure
effective management of the MFI, meaning governance is needed to ensure that MFI’s
are operating, it will then result in attracting people with much-needed skills (usually
from the private sector) that will add growth and make MFI progress. While governance
does not always result in a change of vision for the MFI, it does establish a means of
holding management accountable.
The board should comprise members who have a number of different skills,
including financial, legal, and managerial.
o An MFI must define the following:
o The role of board members both within the board and with regard to
external alliances
o The desired areas of expertise
o The existence of committees to oversee specific areas of operation
o Term limits for board seats
o The process for replacing board members
o The role of the executive director in selecting board members
o The optimum number of board members
o Mechanisms to evaluate the contribution of individual members.
*The private sector, in particular, must be represented. Furthermore, while
selecting a board, the ability to critically assess management's goals as well as provide
appropriate direction is crucial. Board members must be provided with and agree to
clear and common objectives. Members must be independent from the MFI and be
chosen for their expertise rather than their own interests or political agendas or those of
the senior management. Board members should act in such a way that they create
accountability and enable stakeholders to trust one another. So board members should
not receive any personal or material gain other than the approved remuneration.
OWNERSHIP
• Owners of the MFI elect (or at times compose) the governing body of the
institution and through their agents on the board, hold management accountable.
• Ownership is an important but often nebulous issue for MFIs, particularly as
many are funded with donor contributions.
• As MFIs formalize their structures and begin to access funding beyond the
donor community, the “owners” or those that have a financial stake in the
institution can change.
*Ownership does not exist in official financial institutions or non-governmental
organizations. Shareholders in formal MFIs own shares that provide them a residual
claim to the MFI's assets if there is anything left after it has met all of its commitments.
 Owners” of formalized MFIs can generally be divided into four categories:
o NGOs
o Private investors
o Public entities
o Specialized equity funds

*The "owners," or those who have a financial stake in the organization, might
alter as MFIs formalize their structures (that is, transition from being an NGO to a
professional financial institution) and begin to acquire funds from sources other than
the donor community. If the NGO remains a separate entity, it frequently owns a
majority of the new institution's shares. Despite this majority ownership, it is critical
that the MFI and the NGO maintain an arm's length relationship that includes a
transparent and explicit transfer pricing structure.

Accessing Capital Markets

The majority of MFIs fund their activities with donor or government funding
through grants or concessional loans. However, it is becoming evident that donor
funding is limited. As MFIs expand and reach a critical stage of growth, they find that
they cannot sustain their growth with only donor support. Some are beginning to access
capital markets.
Various ways that an MFI can access new capital:
o Debt accessed through guarantee funds, loans, and deposit mobilization
o Equity
o Equity investment funds
o Socially responsible mutual funds
o Securitization of the loan portfolio
Accessing Debt
• For the most part it is necessary to be financially self-sufficient to access
commercial sources of funds.
• Guarantee funds are financial mechanisms that reduce the risk to a financial
institution by ensuring repayment of some portion of a loan.
*Some MFIs, with the backing of donor or international NGOs, may be able to
leverage their donor funding with commercial loans in quantities equal to the donor
funds if they produce enough revenue to at least cover their cash expenditures.
Guarantee funds are used to encourage formal sector banks to lend to small businesses.
They can be used to guarantee a commercial bank loan to a microfinance institution,
which subsequently on-lends cash to its clients, or bank loans directly to micro-
entrepreneurs.
o Three types of guarantee funds that cover the risks of making loans:
o A percentage of the loan principal
o A percentage of the loan principal and the interest lost
o A certain amount of the loan (say, the first 50 percent).
Guarantee funds are usually designed to leverage resources. The more effective
the guarantee mechanism the higher the leverage factor becomes.
*These risk-related design features are some of the most important determinants
of the acceptance and use of a guarantee mechanism by banks. In the end, the goal is to
gradually transfer risk from the guarantee mechanism to the financial institutions that
participate.
Benefits of a Loan Guarantee Program:
• Benefits of a Loan Guarantee Program:
• Additional lending induced by the transfer of part of the lender’s risk to the
guaranteeing organization
• Ability to leverage its equity increases
*An MFI is ready to access commercial financing when it has built an equity
base through past donor grants and has a positive net worth.
Accessing Equity
Capital markets can also be accessed by selling shares of ownership (equity) of
the MFI. For this to be possible the institution must be a formal financial intermediary
with shareholders.
Equity Investment Funds
Equity investment funds provide equity and quasi-equity (subordinated debt) to selected
organizations.
*Equity does not have a fixed yield or maturity, unlike debt securities. Equity
investors, on the other hand, put their money into the MFI's lucrative (producing a great
deal of profit) future in exchange for a part of the profits. Because the microfinance
business has yet to mature to the point where many investors are aware of MFIs'
potential, it may be some time before equity investors play a significant part in MFI
funding arrangements. An equity investment is money put into a firm by buying stock
in the company. A stock exchange is where these shares are usually traded. Quasi
equity, commonly referred to as quasi capital, is a type of loan that resembles equity in
some ways. Flexible payment arrangements or subordinated debt are two of the
qualities. This means that quasi-equity debt is unsecured or has a lower priority than
other debt.
Socially Responsible Mutual Funds
• Screened mutual funds, managers screen companies for social criteria. Profits
are paid to shareholders who choose to invest in these funds because they want
to support socially responsible companies.
• Shared return funds are mutual funds owned by member organizations
(MFIs). Shareholders agree to donate (share) a percentage of the return to the
member organizations.
*Socially responsible mutual funds hold securities in companies that adhere to
social, moral, religious, or environmental beliefs. To ensure the stocks chosen have
values that coincide with the fund's beliefs, companies undergo a careful screening
process. There are two types of socially responsible mutual funds: screened and shared-
return funds. Profits are distributed to shareholders who have chosen to invest in these
funds in order to promote socially responsible businesses. A screened mutual fund, such
as the Calvert Group, is an example. Mutual funds controlled by member organizations
are referred to as "shared return funds" (MFIs). Shareholders agree to distribute (divide)
a portion of the profits to the member groups. DEVCAP (Development Capital Fund) is
an example of a shared mutual fund owned by MFI member organizations.
Securitization
• Securitization links microfinance institutions to capital markets by issuing
corporate debentures backed by the MFI’s portfolio.
 • The purpose of creating a single purpose corporation is to acquire the
microenterprise portfolios of known entities without taking on other risks. The
equity of the single purpose corporation comes from the microfinance
organization and its partners.
*The structure requires the creation of a single purpose corporation, which buys
the microenterprise portfolio and capitalizes itself by issuing debentures into the capital
market. The single-purpose organization utilizes its capital to purchase the portfolio
from an MFI at a discount—that is, for a lower price than the portfolio's face value. The
amount of discount is determined by the portfolio's quality. For securitization to
succeed, the partner must be significant and well respected with an established network
of buyers.
To link with capital markets MFIs must provide clear and solid answers to such
critical questions of governance as:
o Can MFIs that are NGOs or have NGO owners provide financial
markets with the assurance that they will make decisions with the same
standards of prudence as enterprises that have traditional shareholders
with commercial monies at risk?
o Will NGOs be able to resist the temptation to let nonfinancial
considerations— whether lofty or base— overwhelm return
considerations, because, in the absence of commercial shareholders, they
are ultimately accountable only to their institutional mission?
o Can boards of directors of NGOs effectively control management?
o Will donor agencies be able to distinguish between those NGOs that can
live up to the required standards and those that cannot?
o Will such atomized owners be able to participate in a meaningful way,
and, if so, will the cumulative effect of minuscule portions of ownership
lead to commercially sound results?
o Will NGOs that have generated their equity through grants and
donations be able to exhibit the same discipline and rigor as a private
investor?
Institutional Capacity Building
Regardless of institutional type and ways of managing growth, all MFIs need to
periodically review their institutional capacity and consider where they might make
improvements.
Institutional capacity issues include:

• Business planning. An MFI needs to be able to translate its strategic vision into
a set of operational plans based on detailed market and organizational analysis,
financial projections, and profitability analyses.
• Product development. An MFI must be able to diversify beyond its original
credit products into other areas such as savings, which can provide desired
services to clients and accommodate their growth.
• Management information systems. As MFIs grow one of their greatest
 limitations is often their management information system. It is imperative that
an MFI have adequate information systems for financial and human resource
management.
• Financial management. Improvements in accounting and budgeting are often
required to monitor loan portfolio quality, donor subsidies, and the growing
volume of operations. Additional skills are required in:

o The adjustment of financial statements

o Portfolio risk management
o Performance management
o Liquidity and risk management
o Asset and liability management

Efficiency and Productivity Enhancement

MFIs must be able to operate in a way that best combines standardization,
decentralization, and incentives to achieve the greatest output with the least cost.
*MFIs must be able to integrate standardization, decentralization, and
incentives in order to produce the highest output at the lowest cost. They must also
build mechanisms to support employee commitment and accountability, such as
recruiting and selection, remuneration, training, and incentives.
APPENDIX 1.
MFI Operational Review
- A tool used to evaluate the institutional maturity of a microfinance organization.
- Helps an NGO planning to transform into a self-sufficient microfinance
intermediary to evaluate its readiness.
The Tool
- The operational review provides the user with guidelines on how to evaluate a
microcredit program in seven key areas: corporate governance, market and
clients, credit methodology, distribution, human resource management,
computerization, and financial management.
- Each topic includes three sections: documentation, indicators of health, and
transformation issues.
How the Tool Works
- The review involves a thorough documentation of the operating procedures and
institutional characteristics of the organization and an evaluation of these factors
against performance levels currently being achieved by leading micro-finance
institutions worldwide.
- There are two useful products that can result from an operational review:
(1) A detailed documentation of the organization that can be given to visitors,
researchers, funders, and groups who may want to start a microcredit program
and are looking for lessons from current practitioners;
(2) An evaluation of the organization’s readiness for rapid growth and
transformation, comprising of two sections—one on institutional capacity in
general and one on issues particular to transformation.
Operational Review: An Outline
1. Corporate governance
 - It is the system of rules, practices and processes by which a company is directed
and controlled. Corporate Governance refers to the way in which companies are
governed and to what purpose.
2. Markets and clients
3. Credit methodology
- It will increase efficiency, reduce costs, and lessen risk both for the MFI and for the
client.
4. Distribution
5. Human resource management
6. Computerization
7. Financial management
For each topic above, this outline includes three sections:
■ Documentation—A checklist of items to be collected and documented during the review.
■ Indicators of health—Standards against which to evaluate the organization. As we
gain experience with applying the tool, these standards will become more quantitative.
■ Transformation issues—Issues requiring thought and attention if the organization is
contemplating transforming into a regulated financial intermediary.

APPENDIX 2.
Manual for Elaboration of a Business Plan
- Provides guidelines for creating a business plan.
The Tool
- The tool included here is an English summary of the manual, which highlights
the main themes in each chapter and provides some examples of the many
illustrative tables and charts found in the original.
How the Tool Works
- Business Plan is the tool by which an institution’s mission gets translated into
measurable targets.
- In light of its mission, an institution sets targets for the market share it will
achieve by the end of the three-year planning period.
- The Business Plan process begins with an ACCION team (usually two people,
one of whom is often the president) making a visit that includes a formal
presentation of the state of the microfinance program and of its medium-term
goals.
- Most of the work is then carried out by the affiliates themselves, over a period
of two to four months.
- The strength of the business plan lies in the way in which all elements, and every
decision, have a financial implication with an impact on financial performance
and the bottom line.
1. Introduction
✓ What is business planning?
- It is a process by which an organization defines a path from its current
situation to where it wants to be at a determined point in the future.
✓ How is it used?
- It establishes numerically defined objectives, strategies, and actions.
✓ Who participates in the business planning process?
- The entire management team must participate to ensure that all of the
pieces of the planning puzzle fit, resulting in a consistent, coherent plan
✓ What are the characteristics of a successful business plan?

2. Business Plan Format

- Here is the suggested format for a business plan and shows the links to financial status:

3. Institutional Analysis
- Directs the reader to the elements of an institutional analysis that cover its
history, mission, and comparative advantages.
- The institutional analysis is one of the most important parts of the business as it
is the skeleton around which the rest of the plan is elaborated.
4. Basic Premises
- Describes the general economic analysis that should be part of the business plan.
5. Portfolio Analysis and Projections
- The projected portfolio is the “backbone” of the business plan, determining cost
and income.
Determining the market
- To express an institution’s mission in quantitative terms, it is necessary
to define the customer base and estimate the size of the market this
customer base represents.
Defining the competition
- To position the institution in the marketplace, the following information
about the competition should be collected. This information will help to identify
the institution’s strengths and weaknesses and influence strategies for the three-
year planning horizon.
Projecting the portfolio
- Projections of portfolio growth must be made on two levels: loan
volume of existing clients in the current portfolio and loan volume
attributed to new clients
Estimating market penetration
- The relationship of the portfolio projections to the estimated market for
credit yields the market penetration (MP). Calculating the institution’s
market penetration serves as a reality check for the projections:

Classifying the portfolio

- The portfolio must be disaggregated or classified by a number of factors
that have an impact on cash flow and costs.
Interest rate policies
- The final part of portfolio projections is setting the interest rate(s),
which will be based on the following factors:
■ Market rates
■ Operating costs
■ Financial costs
 ■ Capitalization objectives
6. Financing Expansion
 - This chapter identifies various funding sources—their characteristics, costs, and
conditions.
7. Operational Costs—Past and Projected
✓ Offices and staff by city or geographic area
✓ Productivity ratios
✓ Personnel costs
✓ Specific planning for new facilities or renovations
8. Priority Projects
- Some projects merit separate treatment in the business planning process.
✓ Project objectives
- Description, background, the problem to be addressed, and the benefits to be
gained— both qualitative and quantitative.
✓ Costs
- In addition to the impact on operating costs, the plan must account for special
costs associated with these projects, such as the staff training required to operate
a new system.
✓ Timeframe for investments
- A detailed plan of tasks and of the time line for their accomplishment outlines
the process for purposes of control and to identify points when funds will be
needed to finance the project.
✓ Sources of financing for the project
- Precise knowledge of the possible sources of funds for the project is essential to
guarantee results. This involves identifying the sources, their characteristics,
conditions, terms, and process by which to secure funds.

9. Financial Statements
- With these projections completed, all the elements are in place to construct
projected financial statements including the Balance Sheet, the Profit and Loss
Statement, and the Cash Flow Statement.

SUMMARY:

The Institution is all about how can you build a good institution. Institutions play
a vital role in our lives, as they take part in every transaction we do. A financial
institution (FI) is a company engaged in the business of dealing with financial and
monetary transactions such as deposits, loans, investments, and currency exchange. It
encompasses a broad range of business operations within the financial services sector
including banks, trust companies, insurance companies, brokerage firms, and investment
dealers. Financial Institutions especially Microfinance Institutions help people to earn
money, by lending money and giving ways on how to create business and by doing that
they are also helping our economy to grow. Being a good institution takes a lot
consideration, there are things you need to achieve and to maintain, to gain
the trust of the people and choose your institution. Having partners for your institutions
can be an advantage to your institution as they can give information, assets, training,
and knowledge that can be beneficial to your institution and to your clients. To be a
Strong Microfinance Institution are a lot of things you need to possess to be able to
assure the stability of your institution, your institution needs to have a good vision to
lead the business wisely and give motivation to the employees, the business must also
make sure that all of the services they offer are those things that is needed by the
clients. The cash in and cash flow of the MFI’s must be also checked to assure that the
assets and profits of the institution can cover all the expenses of the business.
MFI's are known have a purpose which is to help the people to ease their need
especially in financial aspect. There are different institution types that we applicants or
possible customer can inquire or apply to. These institutional types are formal,
semiformal and informal providers. Let us first discuss the formal, usually these are the
institutions that is usually govern by the government meaning all the transactions are
well manage by the government and you can be rest assured that you will be safe if you
will acquire in these institutions. There are different types of formal institutions, these
are public development banks, private development banks, saving banks and postal
saving banks, commercial banks and non-bank financial institution. Moving on in Semi
formal institution these are the financial institutions that usually manage by both private
entities and NGO's their project is mainly for the micro business owners in their
respective area. We have different types of semiformal institutions these are credit
unions and loan cooperatives and other financial cooperatives, financial NGO's. The last
institutional type is Informal providers, these are the instructions that is not govern by
the government but usually with this type gives less requirements and higher rates, this
is the typical financial provider that you can find everywhere were everyone can
acquire because usually you don't need to have collateral to apply. With these as a
person who need financial assistance there are various financial institution that you can
apply on depending on your needs and rates. Institutional growth and transportation are
one of the crucial part in achieving the long and short term goal of the institution. One
of the way to be competent in this industry is for it to evolve in the form that the market
wants, especially by promoting their purpose in the community. Not like before there
are lot of MFI's nowadays and as an institution we need to do something for us to
generate profit and also to our goal and purpose in the community, with this we need to
find ways on how we can do it. All in all, there are different institutional types that can
help the people we may not be aware but as the market grows it's need also the MFI' s
adjust to it.
 MODULE 5
CLIENT CASH PATTERNS AND LOAN AMOUNTS
To design a loan product to meet borrower needs, it is important to understand the cash
patterns of borrowers. Cash inflows are the cash received by the business or household
in the form of wages, sales revenues, loans, or gifts; Cash outflows are the cash paid by
the business or household to cover payments or purchases. Cash patterns are important
insofar as they affect the debt capacity of borrowers. Lenders must ensure that borrowers
have sufficient cash inflow to cover loan payments when they are due.
How Does the Loan Term Affect the Borrower’s Ability to Repay?
The loan term is one of the most important variables in microfinance. It refers to the
period of time during which the entire loan must be repaid. The loan term affects the
repayment schedule, the revenue to the MFI, the financing costs for the client, and the
ultimate suitability of the use of the loan.
FREQUENCY OF LOAN PAYMENTS
Loan payments can be made on an installment basis (weekly, biweekly, monthly) or in a
lump sum at the end of the loan term, depending on the cash patterns of the borrower.
For the most part, interest and principal are paid together. However, some MFIs charge
interest up front (paid at the beginning of the loan term) and principal over the term of
the loan, while others collect interest periodically and the principal at the end of the
loan term.
WORKING CAPITAL LOANS
are for current expenditures that occur in the normal course of business. Working
capital refers to the investment in current or short-term assets to be used within one
year.
FIXED ASSET LOANS
those made for the purchase of assets that are used over time in the business. These assets
typically have a life span of more than one year. Fixed assets are usually defined as
machinery, equipment, and property.
LOAN COLLATERAL
Generally, MFIs lend to low-income clients who often have very few assets.
Consequently, traditional collateral such as property, land, machinery, and other capital
assets is often not available. Various innovative means of reducing the risk of loan loss
have been developed, including collateral substitutes and alternative collateral.
COLLATERAL SUBSTITUTES
One of the most common collateral substitutes is peer pressure, either on its own or
jointly with group guarantees.
GROUP GUARANTEES
Many MFIs facilitate the formation of groups whose members jointly guarantee each
other’s loans. Guarantees are either implicit guarantees, with other group members
unable to access a loan if all members are not current in their loan payments, or actual
guarantees, with group members liable if other group members default on their loans.
Some MFIs require group members to contribute to a group guarantee fund, which is
used if one or more borrowers fail to repay.
Frequent Visits To The Business By The Credit Officer.
Provided the branch or credit officers are within a reasonable geographical distance
from their clients, frequent visits help to ensure that the client is maintaining the business
and intends to repay the loan. Frequent visits also allow the credit officer to understand
her or his clients’ businesses and the appropriateness of the loan (amount, term,
frequency of payments, and so forth). Visits also contribute to developing mutual
respect between the client and the credit officer as they learn to appreciate and
understand each other’s commitment to their work.
RISK OF PUBLIC EMBARRASSMENT
Because of the fear to be embarrassed, clients repay their loans on time. An example of
this is through posting on social media.
RISK OF JAIL OR LEGAL ACTION
This may vary depending on the legal context of a country, but some clients also pay
their loans on time because of the fear to be sued or even jailed. Being jailed may cause
problems especially when you are in the business industry.
There are three (3) alternative forms of collateral. First is the compulsory savings in
which are not subject to withdrawal, unlike voluntary savings. This compulsory savings
serves as collateral because when a client did not pay their loans, they cannot withdraw
from their savings and this will be accumulated by the MFI as collateral. Next, is the
Asset Pledged at less than the value of the Loan, here, the clients pledged their
equipment, furniture, appliances, and even their house and car just to avail loans. The
third and last alternative form is personal guarantees, if the clients cannot repay their
loans, some people would be responsible for repayment, it could be peers, family, or
colleagues. Through these three compulsory savings, a client would be able to avail of
loans.
Pricing Loan- A balance must be reached between what clients can afford and what
the lending organization needs to earn to cover all of its costs. (Explanation)Pricing
loan A system or process that MFI do in order to provide an affordable interest to a
client while ensuring that bank or the organization is making a profit. To provide
affordable interest MFI has a 4 structure before computing the interest rate;
Four Structure
Financing costs – defined as the other costs incurred by a company while
borrowing fund. (Explanation) Financing cots funds consist a loan portfolio and
compulsory saving. What do you mean my loan portfolio, is the total capital of a bank
or Company while compulsory saving it is a saving payment or requirement a
membership to acquired loan? For example, card bank, rural banks they have a
membership wherein it will be the requirement to acquire loan. In this Financing costs it
acquires collateral and comaker those saving will be the collateral and comaker will be
required to pay the loan when the first person unable to pay its obligation. To derive at
the financing cost here is the formula in computing the annual cost of a loan
Annual Cost = Compulsory Saving (Saving percentage) + Loan Percentage
Total Funds
 Operating cost – include salaries, rent, travel and transportation,
administration, depreciation. (Explanation) To get the interest rate they need to sum up
all the total operating cost such as salaries rent and many. For example, in our bp we
calculated our operating expense to come up in our selling price.
Loan loss provision- depending on the quality of the loan portfolio.
(Explanation) Loan loss provision it is an income statement expense where all the
unpaid loans and loan payments are written and included in the current interest.
Cost of capital- capital costs vary depending on the market rate of interest and
the inflation rate in the country. (Explanation) Cost of capital most common to the MFI.
Economic status, market, government laws dictate which how much interest rate will be
added to the loan of a creditor.
Method in Calculating Interest Rate
Declining Balance Method-This method calculates interest as a percentage of
the amount outstanding over the loan term. Interest calculated on the declining balance
means that interest is charged only on the amount that the borrower still owes. The
principal amount of a one year loan, repaid weekly through payments of principal and
interest, reduces or declines every week by the amount of principal that has been repaid.
To calculate interest on the declining balance, a financial calculator is required. On most
financial calculators, present value and payment must be entered with opposite signs,
that is if present value is positive, payment must be negative, or vice versa. This is
because one is a cash inflow and one is a cash outflow. Financial calculators allow the
user to enter different loan variables as follows:
PV = Present value, or the net amount of cash disbursed to the borrower at the
beginning of the loan.
i = interest rate, which must be expressed in some time units
as n below n = Loan term, which must equal the number of
payments to be made. PMT = Payment made each period.
(Explanation) To compute the Interest rate, MFI uses two method the declining balance
method and the Flat Method. In the Declining Balance Method, it is based on how long
the creditor pay its loan, the longer it takes the higher the interest rate is. Using the
formula PMT in excel you can able to calculate the interest rate.
Flat Method- This method calculates interest as a percentage of the initial loan amount
rather than the amount outstanding (declining) during the loan term. Using the flat
method means that interest is always calculated on the total amount of the loan initially
disbursed, even though periodic payments cause the outstanding principal to decline.
(Explanation) Flat Method will be based on the fix contract on how much will be the
interest rate, it will not be an open contract wherein if you will your loan early it will
lessen the interest rate, no. In Flat Method it is a fix interest, and using a video
presentation I explain how to compute the Flat method.
Interest = Loan x Interest Rate (Percentage)
How Do Fees or Service Charges Affect the Borrower and the MFI?
In addition to charging interest, many MFIs also charge a fee or service charge when
disbursing loans. Fees or service charges increase the financial costs of the loan for the
borrower and revenue to the MFI. Fees are often charged as a means of increasing the
yield to the lender instead of charging nominal higher interest rates. Fees are generally
charged as a percentage of the initial loan amount and are collected up front rather than
over the term of the loan. Because fees are not calculated on the declining balance, the
effect of an increase in fees is greater than a similar increase in the nominal interest rate
(if interest is calculated on the declining balance) (Explanation) In this part I asked the
audience what their opinion regarding to the changes on the service charge by their
banks provider because it is about how the fees and charger affect the borrower and the
MFI. And for the MFI the effect will be the same since they are having or giving an
interest and service charge based on the cost of a loan.
CROSS-SUBSIDIZATION OF LOANS
Cross-subsidization of loans is not very common among MFI’s because they only have
one or two loan products.
Calculating Effective Rates
The effective rate is useful in determining if the conditions of the loan make it more or
less expensive for the borrower and the MFIs. Effective rate includes all the direct
financial costs of a loan in one interest rate that includes interest, fees, interest
calculation method, and other loan requirements.
There are many ways in calculating effective rates, but many MFIs calculate their
interest rate based on a flat basis. When using a flat basis, the interest is calculated on
the total amount of the loan initially disbursed. There are variables of microloans that
influence the calculation of effective rates such as the nominal interest rate, declining or
flat rate, payments, service fees, contribution, compulsory savings, payment frequency,
loan term, and loan amount. These variables have different effects on the calculation
such as increasing and decreasing the effectivity rate of the loans depending on the
declining basis and flat basis method.
We have two (2) methods of calculating the effective rate; the estimation method and
the internal rate of return method.
The estimation method does not directly take into account financial costs unlike the
internal rate of return method that consider all the financial costs.
Estimation cost can be useful in determining the effect of interest rate and could be
calculated using the following formula:
𝐴𝑚𝑜𝑢𝑛𝑡 𝑝𝑎𝑖𝑑 𝑖𝑛 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑓𝑒𝑒𝑠
𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝐶𝑜𝑠𝑡 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑝𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔

Note that to have the Average principal amount outstanding, here is the formula:
(𝑆𝑢𝑚 𝑜𝑓 𝑝𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙 𝑎𝑚𝑜𝑢𝑛𝑡𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 )
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑝𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 =
𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠
The effective rate of loan increases when a loan term is shortened or the loan fee is
increased. This also may vary depending on the method to use, it is a much lesser
percentage when using declining balance because the interest rate is calculated based on
the amount that borrower still owes, while in the flat method, it has a high effectivity
rate because the interest rate is calculated based on the total amount of loan initially
disbursed with the same principal amount and interest rate throughout the loan term.
Internal rate of return is used in determining the effective rate of interest considering
all the financial costs including the time value of money, compulsory savings, and
contributions of other funds. Just note that in calculating the effective rate, there should
be no late payments or defaulted loans to avoid credit risk. But this IRR needs a
financial calculator, and later on, we will discuss that.
Calculating the internal rate of return involves three steps for each alternative; first is to
determine actual cash flow, second is to enter cash flows into the financial calculator,
and the last one is to
multiply or compound the internal rate of return by the number of periods to determine
the annual rate.
Alternatives are as follows; flat interest calculation, all interest paid upfront, loan fee,
change in payment frequency, compulsory savings with interest, and contributions to
group funds.
It is possible to calculate the effective rate using the internal rate of return method
while taking into account the cash flows that may vary during the loan term.
DESIGNING LENDING PRODUCTS
This report by Jullienne F. Canatuan was a continuation of Module 5: Designing
Lending Products. She was the last reporter for this chapter and she had discussed 4
important topics. The first one was the discussion about how effective cost for the
borrower differs from the effective yield to the lender. The second one was Appendix 1,
which discussed how an MFI can set a sustainable rate on its loans. The third one was
Appendix 2, which was about calculating an effective interest rate using the internal
rate of return method. The last topic was Appendix 3, which focused on calculating the
effective rate with varying cash flows.
HOW DOES THE EFFECTIVE COST FOR THE BORROWER DIFFER FROM THE
EFFECTIVE YIELD TO THE LENDER?
The report started off as the reporter asked someone from the class about what she
thinks is the difference between cost for the borrower and yield to the lender.
Afterwards, it was stated that yield refers to the revenue earned by the lender on the
portfolio outstanding including interest revenue and fees. These so-called yields are the
income generated by the MFIs through their lending products that is being offered to
their clients.
It was also discussed that calculating the effective yield is very important because it
helps the MFI in many ways. First, it allows an MFI to determine if enough revenue
will be generated to cover all costs. Of course, an MFI is also a kind of business that
can only operate if there are enough funds or returns, they can use to cover all of the
needed expenses in order to continuously operate. Being able to calculate its effective
yield will help them understand whether or not the income they generate has been able
to cover all of the costs they incurred.
It is also useful for forecasting revenues and determining the effect of changes in
pricing policies on revenue. It is very important to know how to forecast or have
different types of projection when doing these kinds of transactions and as an MFI, one
factor that greatly helps in forecasting is through the use of the calculation for the
effective yield. Because the MFI knows the yield, they are making year by year, they
may be able to know what possible yields will come next. Being able to calculate the
yield will also help the MFI to know if different pricing policies they are making within
the organization affects their revenue. There are times that MFI sets different kinds of
pricing strategies and policies and how these policies affect the income that comes in
the firm will be determined as long as they know the exact yield they are making.
 Projected yield is also useful for MFI's to compare to the actual yield on their
portfolios and this is important so they can assess what possible steps they could make
in order to achieve the best possible results based on the comparison they made.
 The effective yield to the lender differs from the effective cost to the borrower for
two reasons. First, if there are components of the loan pricing that do not result in
revenue for the lender, they are not included in the yield calculation but in the interest
rate for the borrower calculation. Second, the expected yield to lender differs because
the cost to the borrower is determined on the initial loan amount, whereas the return to
the lender must be based on the average portfolio outstanding.
The decision to multiply or compound the periodic rate is based on whether or not
the cost to the borrower or the yield to the lender is being determined.
For the cost to the borrower, the internal rate of return is compounded by the
number of payment periods in a year. The internal rate of return must be compounded
rather than simply multiplied by the number of periods because we assume that the
reinvestment rate of the borrower is equal to the internal rate of return. In other words,
the internal rate of return per period if the amount the borrower forgoes by repaying the
loan in installments (that is, the principal amount available declines with each
installment). Therefore, the return earned per period if the borrower could reinvest
would compound over time.
For the yield to the lender, the per-period rate is multiplied, because we assume
that the revenue generated is used to cover expenses and is not reinvested (only the
principal is reinvested). Therefore, the average portfolio outstanding does not increase
(unless revenue exceeds expenses).
To compound the rate, the periodic internal rate of return must be stated as a
decimal amount rather than as a percentage amount. To do this, the periodic internal
rate of return is divided by 100.
To annualize the periodic rate, the following formula is used:

Annual Internal Rate of Return =(1 + IRRp)ª –1

Where IRRp = internal rate of return per period divided by 100

and ª = the number of periods in a year ( ª = 12 if p is one month; ª = 32 if p is

one week)
For Example:

A 1,000 pesos loan, repaid in 4 equal monthly payments of principal and interest,
with an interest rate of 36 percent per year, calculated on a flat basis result in the
following internal rate of return:
PV = 1000; PMT = -280; n = 4
 PV = present value
PMT = payment made each period
n = loan term which must equal the number of payments to be made

Solving for i (interest rate which must be expressed in same time units as n) yields
an internal rate of return of 4.69 percent. The explanation for calculating this was
shown in the video where we used WPS spreadsheet or Microsoft excel using the
formula for IRR.
After calculating for the IRR, we used the formula, Annual Internal Rate of Return
=(1 + IRRp)ª –1 in order to get the borrower’s effective rate of 73.3 percent
compounded. The yield to the lender turns out to be 56.3 percent since it was just
multiplied, a difference of 17 percent.

The effective yield on the portfolio of an MFI is reduced by different factors. It

could be the amount of delinquent (or non-generating) loans, late payments low loan
turnover (idle funds), fraud. reporting errors or failures that lead to delayed collection
of loans and prepayments if interest is calculated on the declining balance and funds
remain idle. There are times that MFI have these on their transactions, and most of the
time, it affects their yield.

APPENDIX 1.
HOW CAN AN MFI SET A SUSTAINABLE RATE ON ITS LOANS?
MFIs can determine the rate necessary to charge on loans based on their cost
structure. The following is one method of approximating the effective interest rate that an
MFI will need to charge on its loans to cover all of its costs and thus be sustainable.
This method assumes a mature MFI with relatively stable costs, that is, start-up
costs have already been amortized and the MFI is operating at full capacity. The
annualized effective yield
(R) charged on loans is a function of five elements, each expressed as a percentage of
average outstanding loan portfolio (LP): administrative expenses (AE), the cost of
funds (CF), loan losses (LL), the desired capitalization rate (K), and investment income
(II).
Each variable should be expressed as a decimal fraction (percentage of average loan
portfolio).
For example, operating expenses of 200,000 on an average loan portfolio of
800,000 would yield a value of 0.25 for the AE rate.
Included as administrative expenses (AE) are all annual recurrent costs except the
cost of funds and loan losses, including salaries, benefits, rent, utilities, and
depreciation. Administrative expenses of efficient mature organizations tend to range
between 10 and 25 percent of their average loan portfolio.
The loan loss rate (LL) represents the annual loss due to defaulted loans. Past loan
loss experience is an important indicator of this rate. Microfinance organizations with
loan loss rates
greater than 5 percent tend not to be viable. Many good organizations run at about 1 to
2 percent of average outstanding portfolio.
The cost of funds (CF) rate takes into account the actual cost of funds of the
organization when it funds its portfolio with savings and commercial debt. When an
MFI also benefits from concessional funding, the calculation must include an
estimation of the funding costs if it were replaced with commercial debt and equity.
There are two methods suggested to determine the cost of funds:
 The estimation method: multiply the financial assets by the higher of the
rate that localbanks charge medium-quality commercial borrowers or the inflation
rate projected for the planning period.
 The weighted average cost of capital method: based on the sources used
to fund thefinancial assets, including loans to the organization, deposits if
licensed to collect, and equity.
The capitalization rate (K) represents the net real profit that the organization would
like to achieve, expressed as percentage of the average loan portfolio.
The investment income rate (II) is the income expected to be generated by the
organizations’ financial assets, excluding the loan portfolio.
For example, if an organization has operating expenses of 25 percent of its average
loan portfolio, 23.75 percent cost of funds (stated as a percentage of its average loan
portfolio), loan losses of 2 percent, a desired capitalization rate of 15 percent, and
investment income of 1.5percent, the resulting effective annual interest rate is 65.6%.
The most important point to bear in mind when determining the rate to charge is the
efficiency of the organization. The purpose is to provide clients with long term
continued access to the organization, which can only be covered if all of the costs
incurred by the firm are covered.

APPENDIX 2.
CALCULATING AN EFFECTIVE INTEREST RATE USING THE INTERNAL
RATE OF RETURN METHOD
The effective rate is calculated first for a "base case" then the effective rate is
calculated to illustrate the effect of different loan variables including:
- Flat interest calculation
- Up-front interest payments
- Loan (or service) fee
- Change in payment frequency
- Compulsary savings with interest
- Contributions to group funds (no interest)
It would be seen that from the samples given after the base case, different effective
rates are determined depending on the different effect a certain loan variable has on the
base case. This just proves that it is possible for MFIs to know what they are doing and
whether or not they are generating an effective yield through calculations of the
different loan variables involved.
APPENDIX 3.
CALCULATING THE EFFECTIVE RATE WITH VARYING CASH FLOWS
It is also possible to calculate the effective rate by using the internal rate of return
method to take into account cash flows that vary during the loan term.
To calculate the effective rate for a loan that is repaid in a lump sum at the end of
the loan term, the interest rate for the loan term is considered the period rate and,
therefore, the effective rate.
The substantially lower effective rate is a result of the borrower having use of the
full amount of the principal (1000) for the entire loan term of four months.
For the MFI to earn an effective yield to a loan that has principal and interest paid
in installments, the nominal rate would have to be increased considerably.
SUMMARY AND LEARNINGS
It is very important to note that MFIs should be able to calculate for the proper
yield they are generating in every operation they do. They must be able to calculate and
know the different effects of different loan variables that are involved. MFIs are also
businesses that should be able to concentrate in making their firm sustainable aside
from being able to render service to its clients. They must be able to do their operations
in a way that they will be able to know if all of the costs they incur as a business is
covered by all of the revenue, they are generating from it. As a future entrepreneur, it is
important for someone like me to know how these kinds of things work, how it would
help me succeed in the kind of industry I’m getting into and how being able to be
knowledgeable about different types of lending products could help me in my future
endeavors.

MODULE 6:
DESIGNING SAVINGS PRODUCTS
Agenda CHAPTER SIX what this report covers
• Demand for Savings
• Human Resource Legal Requirements Types of Savings for Micro Entrepreneurs
• Institutional Capacity to Mobilize Savings Pricing
Savings Prod Savings are often not available to MFI clients
Poor cannot and do not save 1st REASON
Many MFI' s are not allowed to mobilize deposits 2nd REASON
Subsidized credit funds also contribute to the limited mobilization of savings deposits.
Keep on Investing Always think long-term.
If an MFI is to mobilize savings effectively, there must be suitable economic and
political environments in the country in which it is working. Finally, the institution
itself must have established a good record of sound financial management and internal
controls, which assures depositors that their funds will be safely held by the MFI.
THE MFI
Few MFIs are currently authorized to accept voluntary deposits under current
regulations, which means that there is a limited experience to draw from. However, as
the field matures, more donors and practitioners are realizing that there is a demand for
savings services and best practices will be further developed.
During times of excess cash flow, clients need a safe and convenient way to save.
Low-income clients are often unable to access savings services from traditional banks
due to a limited branch network or the reluctance of banks to deal with small amounts
of money.
Micro entrepreneurs, like other business people, save for at least five reasons
1. Consumption and for consumer durables
2. Social and religious purposes
3. Investments Retirement, ill health, or disability
4. Seasonal variations in cash flow.
5. Savings clients are interested in three major benefits:
Convenience
Liquidity
Security
I am the first one to report about our topic in chapter 6 which is Designing Savings
Product. I began my discussion with a short introduction of what are the importance of
having savings in our life and gave two choices of saving now or saving tomorrow.
Saving now is important especially if you have enough money then you can start saving
now, we have this saying that if you can do it today then don't wait for tomorrow to
come. If we are able to save now go do it so that you will be able to make more savings
when tomorrow comes. On the other hand, saving tomorrow will be applicable when
you have things or an emergency to spend your money with, though you have money now
still you have to prioritize what your money needs to be.
Some reasons were also discussed why savings are not often present or
available to the MFI clients, one is that we have this mistaken belief that financially
challenged clients cannot and do not save and the second is that most MFI's are not
allowed to mobilize deposit for legal reasons. These reasons should be taken into
consideration to be able to design a savings Product that would fit on the capabilities of
the clients. The steps or procedures in order to successfully mobilize savings or deposits
were also tackled for the MFI to have a viable and financially stable to do their job.
 Of course, when we do business, demand is really important for the entity to
assure that the product will have a good position in the market. The savings Product has
more demand in the industry which means this products is in need. During times of
excess cash flows clients need a safe and convenient way of saving where they don't
need to worry whether their family member
will borrow their savings. And since traditional banks don't usually accept small
deposits, this results in having problems when it comes to saving money in a safe place.
That just goes to say that Product savings are really important for these clients to secure
their money and future.
Reasons, why micro-Entrepreneurs save, were also discussed and why clients
are interested in saving at the MFI's.
Is There an Enabling Environment?
MFI needs to be operating in a country in which the financial sector has been
liberalized. The government must not allow unqualified institutions to mobilize public
savings. The government must supervise institutions that mobilize public deposits,
either directly or through an effectively managed body that it approves. External
regulations should be based on international banking standards and more specifically on
international accounting principles. Enabling the environment is very essential in
designing savings products because this will help to abolish interest rate ceilings, control
foreign exchange, and establish reasonable capital requirements. The government must
guide the MFI in order to effectively managed and regulated the MFI. External
regulations also help to reduce and diversify risk in designing provisions, policies and
performance criteria. MFI that are not operating in enabling environment must conduct
market research before regulating so that they will know the things they will consider.
“Well-designed and well-delivered deposit services can simultaneously benefit
households, enterprises, groups, the participating financial institutions, and the
government. Good savings programs can contribute to local, regional, and national
economic development and can help improve equity.”
The statements above are really evident especially that MFI provide solution to
financially challenged individual, capital to small businesses and additional source of
income of other financial institutions. MFI can also contribute to the community
whether to local, regional, and national economic development because of the interest
they are imposing and taxes they are paying.
Legal Requirements for Offering Voluntary Savings
Services Licensing
To accept deposits from the general public, an organization must have a license.
MFIs that are licensed as deposit-taking institutions are generally subject to some form
of regulation and supervision by the country’s superintendent of banks, central bank, or
other government department or entity. Adhering to regulatory and supervisory
requirements usually imposes additional costs on the MFI. MFI needs to be licensed
before collecting savings , this means that there are rules and restrictions need to be
followed in order have an organized operation of MFI.
RESERVE REQUIREMENTS
Reserve requirements refer to a percentage of deposits accepted by an institution
that must be held in the central bank or in a similar safe and liquid form. By mandating a
certain percentage of deposit funds as a reserve, governments restrict MFIs with respect
to the total amount of funds available to them for on-lending. Reserve requirements
needed to ensure the safety of each depositor’s saving. In case of financial loss and
bankruptcy there will be support.
Deposit Insurance
Deposit insurance is established for three main reasons (FAO 1995):
■ It strengthens confidence in the banking system and helps to promote deposit
mobilization.
■ It provides the government with a formal mechanism for dealing with failing banks.
■ It ensures that small depositors are protected in the event of a bank failure.
Deposit insurance plans a safety and protects to depositors, this is generally
government-controlled which will make for an MFI to have backup support to make an
effective system.

Does the MFI Have the Necessary Institutional Capacity to Mobilize

Savings?
Prior to offering voluntary savings services, MFIs must ensure that they have
the institutional structure that allows them to mobilize savings legally and adequate
institutional capacity or the ability to develop it. MFI’s needs to have an institutional
capacity such as an adequate governance, management, staff, operational structures to
provide savings service.
Because MFI’s have found out that clients are interested in savings it become
challenging for them to design cost-effective savings mobilization strategies to respond
to clients. With that there are some things that MFI’s should have and learn.
First is Ownership and Governance. Ownership and Governance have a strong
impact on client perception of MFIs mobilization of service merely because it is their
way to ensure that the institution is safe and good. There are two types of ownership,
public ownership, and privately-owned MFIs. Clients are more into public ownership
because it seems reliable and secure and they believe that the government will protect
them in case of a severe liquidity or solvency crisis. On the other hand, privately owned
MFIs need to ensure that they are perceived to be sound financial intermediaries. They
should build a good relationship with well-respected individuals, families, or religious
institutions that can help strengthen the confidence and trust of depositors.
Second is Organizational Structure. Most MFIs that mobilize savings have
organizational structures that are both extensive and decentralized. As MFIs, they
should have a system that outlines how certain activities are directed in order to achieve
the goals of an organization also focus on the distribution of administrative power from
the main source group to several smaller ones. A location close to deposit customers
reduces transaction costs for both the MFI and its clients and is an important part of
establishing a permanent relationship built on mutual trust, which is a key to successful
savings mobilization. Successful MFIs organize their branches or field offices as profit
centers and employ a method of transfer pricing that ensures full-cost coverage
throughout the branch network. Funding costs are apportioned as well. A branch that
disburses a larger volume of loans than the deposits it collects needs to receive funding
from the head office (or another branch) to fund those loans. If the head office
determines that there is no excess funding within the system, it will then access external
funding and on-lend it to its branches for a set price.
Third is Human Resource. Once savings are introduced, the MFI becomes a true
financial intermediary, and the consequences for the institution and its human resources
are considerable. New service offering requires employees that will be of help to make it
possible because managing
a financial intermediary is far more complex than managing a credit organization,
especially since the size of the organization often increases rapidly. With that, MFIs
should focus on selecting staff from the local region who are familiar with customs and
culture and, if applicable, the dialect spoken in the region. Local staff tend to instill
confidence in clients and make it easier for them to communicate with the MFI.
Furthermore, Managers and staff need to learn how local markets operate, how to locate
potential savers, and how to design instruments and services for that market. They also
need to understand basic finance and the importance of an adequate spread between
lending and deposit services.
Fourth is Marketing. Just like the MFI that requires a lot of papers before they
grant a loan, client/depositors also find an institution whom they can trust with. Deposit
clients must be convinced that the MFI staff is competent and honest. With that, the
MFI must first design its savings products appropriately and then publicize its services
in locally appropriate ways. One way is through giving gifts when they open a savings
account. Displaying of posters showing pictures of the local sub-branch can also be a
form of marketing because savers tend to be concerned about placing their savings in
what appears to be a small local bank. Other than that is what they called “open door”
wherein clients can come in and meet staff as well as physically see the safe where the
money is kept. Lastly is through word of mouth. To ensure positive word of mouth, the
service provided to depositors must be timely, considerate, and honest. Once again,
client demand must ultimately be met through appropriate savings product design.

INFRASTRUCTURE
Introducing voluntary savings products greatly alters the organization and
management of an MFI. We have hundreds of MFI in the Philippines and some of them
provide mobile banking and the rest develop and locate their branches closer to their
client.
MFI has different collection methods; it can be through a passbook together
with ATM or only a passbook then the transaction is exclusively over the counter or
through online transactions for withdrawals and deposits together with ATM. MFIs can
provide mobile banking services or the staff can travel to the locations of the client to
collect savings rather than having the client visit the branch.
Example no. 1
In Bank Rakyat Indonesia, the employees of Bank Rakyat travels to the village
of their client every week to collect savings and withdrawals. Aside from traveling, they
also expand their service by providing mobile banking to offer assistance and allow the
clients for easy and convenient financial transactions. The employee base and gets their
reference through their mobile banking app for the amount of money that they need to
provide for withdrawals before going to the villages. If the employee is consistent in
collecting and handling withdrawals of clients every week the mobile banking app will
work well.
Example no. 2
 The BancoSol in Latin America. The MFIs enhance their branch structures to
make them more convenient for their clients and more user-friendly. The Bank offers
services and operates savings accounts, micro-insurance, ATMs, debit cards, and
remittances to every Bolivian who
lives inside Latin America and also for those who live outside the country. The client
who lives outside the country can still do transactions like sending money to their family
who live inside the country. The structures of the MFI in BancoSol are designed simple
and accessible to their client who lives inside and outside of the country.

SECURITY AND INTERNAL CONTROLS

Why security and internal controls are needed to purchase in microfinance
institutions? The MFI needs to purchase a safe to keep cash available for potential
withdrawals and to minimize the risk of robbery. One of the biggest concerns of clients
once they open savings and investment with the Bank is the safety and security that the
Bank can provide.
We have this so-called internal fraud, which leads to economic loss for financial
service providers. This is the unexpected financial loss as the result of fraudulent
activities of persons working inside the firm. For example, an employee made an
electronic fund transfer from one account to another without informing the client or
financial service providers.
To avoid such cases, MFI’s need to develop internal controls to address security
risks when providing voluntary savings products. Microfinance banks need to
implement comprehensive fraud management programs with stronger internal controls.
Examples of security and internal controls are OTP that we receive through text or
email to confirm the transaction or the provided username and password or biometrics
to proceed and unlock the mobile banking app.

MANAGEMENT INFORMATION SYSTEMS

An effective management information system becomes fundamentally
important when savings services are introduced both for internal management and
external reporting.
Management Information System is commonly referred to as MIS. It is easy to
define that it is a system that provides information to management. It provides
information on saving services, offers, and investment transactions in an institution.
MIS should be simple, transparent, and objective because when it is properly
implemented it will help achieve a high level of efficiency in the company's
management operations and deliver good terms and conditions that can client refers to.
So, more clients will invest when it comes to savings because the delivery of the service
of the bank is clear and hassle-free when it comes to its terms and conditions.
Three major goals for an information system:
• Transaction processing - A transaction process system (TPS) is an information
processing system for business transactions involving the collection and
retrieval of all transaction data. The results of each transaction in the
microfinance loan system are real-time, meaning the transaction history of the
institution is always available and accessible in operation and so on.
 • Customer service - MIS also included Customer Service. The aim is mainly to
satisfy customer requirements or manage customer complaints during their
transaction. Microfinance institutions must ensure that clients are treated in a
fair and transparent manner, which includes retaining customers, building
through word-of-mouth business, competitive advantages, and working
efficiently.
• Management information - includes accurate and up-to-date information of every client.
To make strategic decisions about the savings products, the MFI needs the
following information:
✓ Number of accounts
✓ The value of accounts and average balances
✓ Number of transactions per account
✓ The distribution of the balances of the accounts
✓ Daily turnover as a percentage of balances.
Systems must be designed to ensure that this information is produced regularly
and that it also provides information that is beneficial to the MFI itself. It is important
to maintain client information and data. Also, it is important for management
information systems to provide the reporting and monitoring requirements for
regulating the MFI for the client's loan system.

RISK MANAGEMENT AND TREASURY

Publicly owned MFIs often rely on large savings deposits from state-owned
institutions or legally enforced deposits from commercial banks, which implies
heightened liquidity risk if government regulations change and they lose their large
depositors.
The money that the client deposited to the bank is what microfinance providers
use for other clients' loan applications. But it happens that most MFIs generate small
amounts of deposits from their clients and they assist the number of withdrawals.
Because of that scenario, MFIs create a central funding facility in which MFIs can
borrow from other banks and investors or issue bonds; take deposits from clients; and
accept equity investments, which are ownership stakes that earn a share of the profits.
Sequencing the Introduction of Savings Services

It is mentioned in the previous reports of this chapter that most of the services
that MFI’s offer is lending and not savings because it is difficult for MFI to mobilize
savings services. And in this topic, the step-by-step process of introducing and
mobilizing services will be discussed to further know how to do it and its importance
why it should be followed. MFI’s that are planning to introduce voluntary services
should consider these steps to execute it all properly.

The Sequencing of Voluntary Savings Mobilization

 First step, all the people that will be engaged in the mobilization of savings
services must be knowledgeable about voluntary savings AND should also understand
what is happening or the experiences of having this service locally and internationally.
By doing this, they can build on existing systems.
 Second step, just like any other organizations when they are trying to innovate
or try something new, market research is needed to properly understand the needs of
the market or the MFI’s clients. After doing market research, the organization must do
a pilot stage to see if their planning and research is effective.
Third step, after the first pilot stage, an evaluation is needed to assess how does
the first pilot go. If there are parts that needed to be changed or improve and then
conduct another pilot stage and evaluate again the second results until the desired
outcome has met.
Fourth step, hold wider staff training. During this period pay attention to
planning the logistics and management information systems that will be required for the
expansion of the program of deposit mobilization.
Fifth step, gradually expand savings mobilization throughout all your branches.
Make sure that staff training is completed, information systems and instruments are all
ready and applied.
Lastly, when expansion of saving services to all branches is achieved, switch
attention from the logistics of expansion to the techniques of market penetration.

“Haste makes waste” do not be too excited mobilizing voluntary saving just
because it is in demand in your area. Always do the proper sequence and process to
make sure that the results will not be a failure. The process may be too lengthy and
costly but it is better to take precautions than take risks that we are not knowledgeable
about which may result in loss of clients because of poor service.

Most Savings Products for Micro clients Include the Following Features:

Listed about and mostly what a micro client will be encountering if they were to
open and account to an MFI and same goes with the MFI, listed above are some of the
features that MFIs require to a client. When opening saving account there are minimum
balances that needed to be secured and an MFI may also charge fees for opening and/or
closing an account. There are different products that an MFI offers which are: Liquid,
Semiliquid, and Fixed Term Deposits. If an MFI put interests in their lending services,
in savings services they are giving away interests to encourage clients to increase their
deposits and refrain from withdrawing because MFI’s uses these deposits as their source
of fund to their lending services.

Three broad deposit groups based on the degree of liquidity:

There are different savings products that are mentioned previously and here are
its explanations.
Liquid accounts are deposits that allows the savers to deposit and withdraw
anytime they want. There are savings are liquid because it is easily converted to cash.
However, this type of accounts has lowest returns because their savings or balances do
not stay longer in their accounts in which is a disadvantage to MFIs because it is
difficult to manage that they must secure a large amount of deposit to be able to always
service withdrawal requests of the clients. Only a limited portion of the deposits are
used in these accounts which is not favorable to be used as provider of loans.
 Semiliquid accounts on the other hand gives a nominal interest to savers
depending on the minimum balance that they can hold to their accounts over a period.
In this, savers may deposit anytime they want but MFIs give a limited number of
withdrawals.
Fixed term deposits on the other hand are a stable source of funding for MFI
and easy to manage because these are savings accounts that are locked in for a specified
amount of time in which in return gives the savers highest returns but it has the lowest
liquidity.

Choosing savings products depends on what the client chooses and needs.
Mostly, first time savers may choose liquid accounts but as they become experienced,
they are now turning into fixed term deposits. On the part of the MFI, it is automatically
favorable to them that choosing fixed term deposits is way better because they can easily
manage it and is a stable source of funding to provide loans.

Costs of Mobilizing Voluntary Savings

The cost of savings mobilization is not only depending on internal factors like
operational efficiency but also the external factors such as the minimum reserve
requirements, tax rates and the general market conditions.
It is important for a Micro Finance Industry who are offering savings products to
know the internal and external cost for them to be able to know the price of their saving
offers.
Costs include:
• Set up Cost
• Direct Cost
• Indirect Cost
• Cost of Funds
Set up costs include research and development which include hiring outside
consultants and savings experts. Knowing that the offers are new and in the first stage of
the development process, it is important to consider hiring people who are experts in
savings products. Also, the printing of passbooks and other marketing materials for the
initial launch, safes to protect the savings, and also the computer systems including
software and hardware. It is needed for easy transactions and to record safely. As well
as the existing or new staff that is also needed to be paid. All these costs must be
estimated and well planned for developing savings products.
Direct costs is the costs in providing savings services. It can be variable or fixed
costs. In variable costs, it is incurred per account or per transactions. It includes time
and materials in opening, maintaining and closing of accounts. The costs here can be
estimated per account base on the process of transactions.
Fixed cost is incurred to delivery savings products that do not vary with the
number of accounts. It includes the salaries and ongoing trainings for savings officers and
if there’s additional management or branch infrastructure and any special promotions
for savings services.
In Indirect cost, it is not relating directly in providing services but in the portion
charged in the operation of savings as part of overall services the is provided by the
organization. It includes here the overhead cost, the premises and the costs in operation.
As well as the other head office
and the branch costs. The costs here depend on the method that are using in providing
savings products.
Cost of Funds refers to the interest rate paid to depositors. The cost of funds is
the interest rate that is paid by financial institutions that they borrowed for the business.
It is one of the most important in every institution because they can earn higher amount
through funds that have been used for borrowers.

Pricing Savings Products

There are two risk that need to be considered in pricing savings products:
Liquidity risk and Interest rate risk
Liquidity risk is the inability of an institution to meet their financial obligations
with the liquid assets available to them.
Interest rate risk is the potential for investment losses that result from a change
in interest rate. When interest rates arise, it is possible that the value of bond or other
investment will decline.
It is important to consider the risks based on the time period deposits. It is
because the costs of these risks in providing voluntary savings will affect the price of
savings services. Savings products need to be priced for the MFI to earn profit