Frequently Asked Questions About Micro Finance

1. What is microfinance?

To most, microfinance means providing very poor families with very small loans (microcredit) to help them engage in productive activities or grow their tiny businesses. Over time, microfinance has come to include a broader range of services (credit, savings, insurance, etc.) as we have come to realize that the poor and the very poor who lack access to traditional formal financial institutions require a variety of financial products. Microcredit came to prominence in the 1980s, although early experiments date back 30 years in Bangladesh, Brazil and a few other countries. The important difference of microcredit was that it avoided the pitfalls of an earlier generation of targeted development lending, by insisting on repayment, by charging interest rates that could cover the costs of credit delivery, and by focusing on client groups whose alternative source of credit was the informal sector. Emphasis shifted from rapid disbursement of subsidized loans to prop up targeted sectors towards the building up of local, sustainable institutions to serve the poor. Microcredit has largely been a private (non-profit) sector initiative that avoided becoming overtly political, and as a consequence, has outperformed virtually all other forms of development lending.Traditionally, microfinance was focused on providing a very standardized credit product. The poor, just like anyone else, need a diverse range of financial instruments to be able to build assets, stabilize consumption and protect themselves against risks. Thus, we see a broadening of the concept of microfinance--our current challenge is to find efficient and reliable ways of providing a richer menu of microfinance products.

2. What is the difference between microfinance and microcredit?

Microfinance refers to loans, savings, insurance, transfer services and other financial products targeted at low-income clients. Microcredit refers to a small loan to a client made by a bank or other institution. Microcredit can be offered, often without collateral, to an individual or through group lending.

3. Who are the clients of microfinance?

The typical microfinance clients are low-income persons that do not have access to formal financial institutions. Microfinance clients are typically self-employed, often household-based entrepreneurs. In rural areas, they are usually small farmers and others who are engaged in small income-generating activities such as food processing and petty trade. In urban areas, microfinance activities are more diverse and include shopkeepers, service providers, artisans, street vendors, etc. Microfinance clients are poor and vulnerable non-poor who have a relatively stable source of income. Access to conventional formal financial institutions, for many reasons, is directly related to income: the poorer you are, the less likely that you have access. On the other hand, the chances are that, the poorer you are, the more expensive or onerous informal financial arrangements. Moreover, informal arrangements may not suitably meet certain financial service needs or may exclude you anyway. Individuals in this excluded and under-served market segment are the clients of microfinance.As we broaden the notion of the types of services microfinance encompasses, the potential market of microfinance clients also expands. For instance, microcredit might have a far more limited market scope than, say, a more diversified range of financial services which includes various types of savings products, payment and remittance services, and various insurance products. For example, many very poor farmers may not really wish to borrow, but rather, would like a safer place to save the proceeds from their harvest as these are consumed over several months by the requirements of daily living.

4. How does microfinance help the poor?

Experience shows that microfinance can help the poor to increase income, build viable businesses, and reduce their vulnerability to external shocks. It can also be a powerful instrument for self-empowerment by enabling the poor, especially women, to become economic agents of change. Poverty is multi-dimensional. By providing access to financial services, microfinance plays an important role in the fight against the many aspects of poverty. For instance, income generation from a business helps not only the business activity expand but also contributes to household income and its attendant benefits on food security, children's education, etc. Moreover, for women, who, in many contexts, are secluded from public space, transacting with formal institutions can also build confidence and empowerment. Recent research has revealed the extent to which individuals around the poverty line are vulnerable to shocks such as illness of a wage earner, weather, theft, or other such events. These shocks produce a huge claim on the limited financial resources of the family unit, and, absent effective financial services, can drive a family so much deeper into poverty that it can take years to recover.

5. When is microfinance NOT an appropiate tool?

Microfinance increasingly refers to a host of financial services—savings, loans, insurance, remittances from abroad, and other products. It is hard to imagine that there would be any family in the world today for which some type of formal financial service couldn't be designed and made useful. But the fact of the matter is, that in most people's mind, "microfinance" still refers to microcredit.

Microcredit is only useful in certain situations, and with certain types of clients. As we are finding out, a great number of poor, and especially extremely poor, clients exclude themselves from microcredit as it is currently designed. Extremely poor people who do not have any stable income—such as the very destitute and the homeless—should not be microfinance clients, as they will only be pushed further into debt and poverty by loans that they cannot repay. As currently designed, microcredit requires sustained, regular, and often significant payments from poor families. At some level, the very cause of poverty is the lack of a sustained, regular, and significant income. Even though a family may have a significant income for extended periods, it may also face months of no income, thereby reducing its ability to enter into the type of commitment demanded today by most MFIs. Some people are just too poor, or have incomes that are too undependable to enter into today's loan products. These extremely poor people at the bottom percentiles of those living below the poverty line need safety net programs that can help them with basic needs; some of these are working to incorporate plans to help “graduate” recipients to microfinance programs.Often times governments and aid agencies wish to use microfinance as a tool to compensate for some other social problem such as flooding, relocation of refugees from civil strife, recent graduates from vocational training, and redundant workers who have been laid off. Since microcredit has been sold as a poverty reduction tool, it is often expected to respond to these situations where whole classes of individuals have been “made poor”. Microcredit programs directed at these types of situations rarely work. Credit requires a 98% “hit” rate to be successful. This means that 98% of recent vocational school graduates or returning refugees would need to be successful in establishing a microenterprise for repayment rates to be high enough to allow for a program's overall sustainability. This is simply unrealistic. Running a program with substantial default rates undermines the very notion of credit and destroys credit discipline among those who could repay promptly but who look foolish given that many do not.Microcredit serves best those who have identified an economic opportunity and who are in a position to capitalize on that opportunity if they are provided with a small amount of ready cash. Thus, those poor who work in stable or growing economies, who have demonstrated an ability to undertake the proposed activities in an entrepreneurial manner, and who have demonstrated a commitment to repay their debts (instead of feeling that the credit represents some form of social re-vindication), are the best candidates for microcredit. The universe of potential clients expands exponentially however, once we take into account the broader concept of “microfinance”.

6. Why do MFIs charge such high interest rates to poor people?

Providing financial services to poor people is quite expensive, especially in relation to the size of the transactions involved. This is one of the most important reasons why banks don't make small loans. A $100 dollar loan, for example, requires the same personnel and resources as a $2,000 one thus increasing per unit transaction costs. Loan officers must visit the client's home or place of work, evaluate creditworthiness on the basis of interviews with the client's family and references, and in many cases, follow through with visits to reinforce the repayment culture. It can easily cost US$25 to make a microloan. While that might not seem unreasonable in absolute terms, it might represent 25% of the value of the loan amount, and force the institution to charge a “high” rate of interest to cover its cost of loan administration.The microfinance institution could subsidize the loans to make the credit more "affordable" to the poor. Many do. However, the institution then depends on permanent subsidy. Subsidy-dependent programs are always fighting to maintain their levels of activity against budget cuts, and seldom grow significantly. They simply aren't sustainable, especially if other microcredit operations have shown that they can provide credit and grow on the basis of “high” rates of interest—and along the way serve far greater numbers of clients. Evidence shows that clients willingly pay the higher interest rates necessary to assure long term access to credit. They recognize that their alternatives—even higher interest rates in the informal finance sector (moneylenders, etc.) or simply no access to credit—are much less attractive for them. Interest rates in the informal sector can be as high as 20 percent per day among some urban market vendors. Many of the economic activities in which the poor engage are relatively low return on labor, and access to liquidity and capital can enable the poor to obtain higher returns, or to take advantage of economic opportunities. The return received on such investments may well be many times greater than the interest rate charged.Moreover, the interest rate is only a small part of their overall transaction cost of credit, and if microfinance institutions offer credit on a more accessible basis, substantial costs in terms of time, travel, paperwork, etc. can be reduced, thus benefiting the poor. A long series of studies has shown that many programs that charge subsidized interest rates end up using rationing mechanisms to distribute credit in response to excess demand. These mechanisms cause the borrower to have to “jump through hoops”, increasing the time and money s/he must put out to get the loan. In fact, these transactions costs are frequently higher than the interest costs, which takes away the advantage to the borrower of the interest rate subsidy. However, while increased access to credit for the poor on a long term and sustainable basis can bring significant benefits, MFIs must continue to work to improve efficiency levels, and to increase scale. This will bring down the cost of providing loans, and the benefits transferred to the poor in terms improving loan products, better access to loans, and lower borrowing costs.

7. Aren't the poor too poor to save?

The poor already save in ways that we may not consider as "normal" savings--- investing in assets, for example, that can be easily exchanged to cash in the future (gold jewelry, domestic animals, building materials, etc.). After all, they face the same series of sudden demands for cash we all face: illness, school fees, need to expand the dwelling, burial, weddings. These informal ways that people save are not without their problems. It is hard to cut off one leg of a goat that represents a family's savings mechanism when the sudden need for a small amount of cash arises. Or, if a poor woman has loaned her "saved" funds to a family member in order to keep them safe from theft (since the alternative would be to keep the funds stored under her mattress), these may not be readily available when the woman needs them. The poor need savings that are both safe and liquid. They care less about the interest rates that they can earn on the savings, since they are not used to saving in financial instruments and they place such a high premium on having savings readily available to meet emergency needs and accumulate assets.These savings services must be adapted to meet the poor’s particular demand and their cash flow cycle. Most often, the poor not only have low income, but also irregular income flows. Thus, to maximize the savings propensity of the poor, institutions must provide flexible opportunities--- both in terms of amounts deposited and the frequency of pay ins and pay outs. This represents an important challenge for the microfinance industry that has not yet made a concerted attempt to profitably capture tiny deposits.

8. What is a Microfinance Institution (MFI)?

Quite simply, a microfinance institution is an organization that offers financial services to low income populations. Almost all of these offer microcredit and only take back small amounts of savings from their own borrowers, not from the general public. Within the microfinance industry, the term microfinance institution has come to refer to a wide range of organizations dedicated to providing these services: NGOs, credit unions, cooperatives, private commercial banks and non-bank financial institutions (some that have transformed from NGOs into regulated institutions) and parts of state-owned banks, for example.The image most of us have when we refer to MFIs is of a “financial NGO”, an NGO that is fully and virtually exclusively dedicated to offering financial services; in most cases microcredit NGOs are not allowed to capture savings deposits from the general public. This group of a few hundred NGOs have led the development of microcredit, and subsequently microfinance, the world over. Most of these constitute a group that is commonly referred to as "best practice" organizations, ones that employ the newest lending techniques to generate efficient outreach that permit them to reach down far into poor sectors of the economy on a sustainable basis.A great many NGOs that offer microcredit, perhaps even a majority, do many other non-financial development activities and would bristle at the suggestion that they are essentially financial institutions. Yet, from an industry perspective, since they are engaged in supplying financial services to the poor, we call them MFIs. The same sort of situation exists with a small number of commercial banks that offer microfinance services. For our purposes, we refer to them as MFIs, even though only a small portion of their assets may actually be tied up in financial services for the poor. In both cases, when people in the industry refer to MFIs, they are referring only to that part of the institution that offers microfinance.There are other institutions, however, that consider themselves to be in the business of microfinance and that will certainly play a role in a reshaped and deepened financial sector. These are community-based financial intermediaries. Some are membership based such as credit unions and cooperative housing societies. Others are owned and managed by local entrepreneurs or municipalities. These institutions tend to have a broader client base than the financial NGOs and already consider themselves to be part of the formal financial sector. It varies from country to country, but many poor people do have some access to these types of institutions, although they tend not to reach down market as far as the financial NGOs.

9. Can microfinance be profitable?

Yes it can. Data from the MicroBanking Bulletin reports that 63 of the world's top MFIs had an average rate of return, after adjusting for inflation and after taking out subsidies programs might have received, of about 2.5% of total assets. This compares favorably with returns in the commercial banking sector and gives credence to the hope of many that microfinance can be sufficiently attractive to mainstream into the retail banking sector. Many feel that once microfinance becomes mainstreamed, massive growth in the numbers of clients can be achieved.Others worry that an excessive concern about profit in microfinance will lead MFIs up-market, to serve better off clients who can absorb larger loan amounts. This is the “crowding out” effect. This may happen; after all, there are a great number of very poor, poor, and vulnerable non-poor who are not reached by the banking sector.It is interesting to note that while the programs that reach out to the poorest clients perform less well as a group than those who reach out to a somewhat better-off client segment, their performance is improving rapidly and at the same pace as the programs serving a broad-based client group did some years ago. More and more MFI managers have come to understand that sustainability is a precursor to reaching exponentially greater numbers of clients. Given this, managers of leading MFIs are seeking ways to dramatically increase operational efficiency. In short, we have every reason to expect that programs that reach out to the very poorest microclients can be sustainable once they have matured, and if they commit to that path. The evidence supports this position.

10. Are commercial banks involved in microfinance?

Yes. Increasingly, formal financial institutions are recognizing the benefits of serving poorer clients. For more information, see the following documents in the Microfinance Gateway Library:
CGAP: 227 Formal Financial Institutions http://microfinancegateway.org/content/article/detail/18156
Thirty Global Examples of Commercial Banks and Formal Financial Institutions (FFIs) with Established Microfinance Services http://microfinancegateway.org/content/article/detail/21504

11. What is the government’s role in supporting microfinance?

Governments have a complicated role when it comes to microfinance. Until recently, governments generally felt that it was their responsibility to generate development finance', including credit programs for the disadvantaged. Twenty years of insightful critique of rural credit programs revealed that governments do a very bad job of lending to the poor. Short term political gain is just too tempting for politically controlled lending organizations; they disburse too quickly (and thoughtlessly) and they collect too sporadically (unwillingness to be tough on defaulters). In urban areas, governments never really got into the act, and subsidized microenterprise credit is still relatively rare when compared to its rural counterpart. Now that microfinance has become quite popular, governments are tempted to use savings banks, development banks, postal savings banks, and agricultural banks to move microcredit. This is not generally a good idea, unless the government has a clear acceptance of the need to avoid the pitfalls of the past and a clear means to do so. Many governments have set up apex facilities that channel funds from multilateral agencies to MFIs. Apex facilities can be quite complicated and there are few successful examples in microfinance. Successful apex organizations in microfinance tend to be built on the backs of successful MFIs, not the other way around. Finally, governments can also get involved in microfinance by concerning themselves with the regulatory framework that impinges on the ability of a wide range of financial actors to offer financial services to the very poor. This topic is treated below.

12. What is the role of the financial regulator in supporting the development of microfinance?

Many feel that the most important role of a financial regulator in supporting the development of microfinance is to create an alternative institutional type that allows sound financial NGOs, credit unions, and other community-based intermediaries to obtain a license to offer deposit services to the general public and obtain funds through apex organizations. In a few countries, this may be an appropriate strategy. In most countries, however, the general level of development of the microfinance industry does not yet warrant the licensing of a separate class of financial institutions to serve the poor. And, in most countries, budgetary restrictions faced by bank regulators make it very unlikely that they will be able to supervise a whole host of small institutions; these institutions' total assets may make up a tiny percent of the total financial system, but the cost of adequate supervision could eat up between 25 and 50 % of the total budget of the agency.Rather, regulators can work with the nascent microfinance industries of most countries on issues such as modifying usury limits as stated in the commercial code to allow appropriate levels of interest, generating credit information clearinghouses to share information on defaulting borrowers to limit their ability to go from one MFI to another, working with civil authorities to ensure that private loan contracts can be recognized by courts in those transition economies that lack even basic legislative infrastructure, and reporting requirements that will prepare MFIs to eventually become regulated.Regulators can also examine the laws, executive decrees, and internal regulations that limit the ability of traditional banking institutions to do microfinance. These regulations include limits on the percent of a loan portfolio that can be lent on an unsecured basis, limits on group guarantee mechanisms, reporting requirements, limits on branch office operations (scheduling and security), and requirements for the contents of loan files. Not least, banking regulators may need to look at the way in which they would evaluate microloan portfolios within large banks.

13. Are there training courses that would enable me to get more in-depth exposure to microfinance?

Yes. A number of institutions provide workshops and trainings on microfinance topics from product costing to accounting to MFI management to reaching the poor, and much more. Trainings vary in length, location, and cost…please consider the institutions listed below as a starting point in learning more about microfinance training. See also the Events page of the Gateway for specific announcements of upcoming workshops.

The Boulder Microfinance Training Program http://learning.itcilo.org/entdev/microfinance/

Southern New Hampshire University Microfinance Practitioner Training http://www.mdi-nh.org/

Microfinance Management Institute http://www.themfmi.org/

CGAP Donor Information Resource Centre Training Modules http://www.cgap.org/direct/resources/modules.html

CGAP Skills for Microfinance Managers Program http://www.cgap.org/projects/SMM.html

Bankakademie Training http://www.training.bankakademie.de/ShowFlash/140

EDA Rural Systems – Training & Capacity Building http://www.edarural.com/training.htm

Microfinance Centre for CEE & NIS – Training and Consulting http://www.mfc.org.pl/index.php?section=TC&page=Course%20Content

MicroSave Training Curricula and Workshops http://www.microsave.org/toolkits.asp?ID=14

Programme de renforcement des capacities des institutions de microfinance en Afrique francophone (CAPAF) http://www.capaf.org/index.html

UNCDF Microfinance Distance Learning Course http://www.uncdf.org/english/microfinance/MFcourse.php

14. What are some key microfinance websites, other than the Microfinance Gateway?

Listed below are the most-often accessed microfinance-related websites

Microfinance Information eXchange (MIX) http://www.themix.org/

Consultative Group to Assist the Poor (CGAP) http://www.cgap.org/

PlaNet Finance http://www.planetfinance.org/

World Bank http://www.worldbank.org/

ACCION http://www.accion.org/

USAID MicroLinks http://www.microlinks.org/

Virtual Library on Microcredit http://www.gdrc.org/icm/

Microfinance.com http://www.microfinance.com/

GTZ http://www.gtz.de/

UN Capital Development Fund http://www.uncdf.org/english/microfinance/index.php

MicroSave http://www.microsave.org/

Grameen Bank http://www.grameen.org/

EnterWeb http://www.enterweb.org/

Food and Agriculture Organization of the UN (FAO) http://www.fao.org/

Microfinance Network http://www.bellanet.org/partners/mfn/

Microfinance Center for CEE & NIS http://www.mfc.org.pl/

SEEP Network http://www.seepnetwork.org/

Development Gateway http://www.developmentgateway.com/

15. Where can I learn more about microfinance in Europe and Central Asia?

Regional Organizations

ABCUL Credit Unions http://www.abcul.org/page/index.cfm

Association Pour Le Droit a l’Initiative Economique (ADIE) http://www.adie.org/

Microfinance Centre for CEE & NIS http://www.mfc.org.pl/

Microcredit European Conference http://europa.eu.int/comm/enterprise/events/microcredit/

PlaNet Finance http://www.planetfinance.org/PlaNetFinance/PagePortail/index.htm

Regional Documents

Benchmarking Microfinance in Eastern Europe and Central Asia http://www.mixmbb.org/publications/ECA%20Benchmarking%20Report%202004.pdf

Microfinance in Conflict-Affected Environments http://microfinancegateway.org/content/article/detail/20028

16. Where can I learn more about microfinance in the Middle East and North Africa?

Regional Organizations

Al Amana http://www.alamana.org/

Enda Inter-Arabe http://www.endarabe.org.tn/

Fondation Zakoura http://www.zakourafondation.org/

Sanabel Microfinance Network of the Arab Countries http://www.sanabelnetwork.org/

Social Fund for Development-Yemen http://www.sfd-yemen.org/SMED_Unit.htm

Regional Documents

Benchmarking Arab Microfinance http://www.mixmbb.org/ArabBenchmarkingReport.pdf

Making Microfinance Work in the Middle East and North Africa http://microfinancegateway.org/content/article/detail/19801

Microfinance in the Arab States http://www.uncdf.org/english/microfinance/books/UNCDF_mfArab.pdf

17. Where can I learn more about microfinance in Sub-Saharan Africa?
Regional Organizations

African Development Bank Group http://www.afdb.org/home.htm
Africa Microfinance Network (AFMIN) http://www.afmin-ci.org/
African Rural and Agricultural Credit Association (AFRACA) http://www.gdrc.org/icm/afraca/afraca.html
FinMark Trust http://www.finmarktrust.org.za/
Microfinance Regulatory Council http://www.mfrc.co.za/index.php
MicroSave Africa http://www.microsave-africa.com/
Programme de renforcement des capacities des institutions de microfinance en Afirque francophone (CAPAF) http://www.capaf.org/

18. Where can I learn more about microfinance in East Asia and Pacific?

Regional Organizations

Asian Development Bank: http://www.adb.org/Microfinance/default.asp


Asia Pacific Rural and Agricultural Credit Association http://www.apraca.th.com/

Asia Resource Center for Microfinance (Banking with the Poor) http://www.bwtp.org/

Bank Rakyat Indonesia http://www.bri.co.id/

Bank Rakyat Indonesia International Visitor Program http://www.bri.co.id/Microbanking/ivp.asp

Credit and Savings for the Hard-Core Poor (CASHPOR) http://www.cashpor.org/

Japan Bank for International Cooperation http://www.jbic.go.jp/english/index.php

19. Where can I learn more about microfinance in South Asia?
Regional Organizations

Asian Development Bank: Microfinance http://www.adb.org/Microfinance/default.asp
BRAC (formerly known as Bangladesh Rural Advancement Committee)

http://www.brac.net/

Centre for Microfinance Nepal http://www.cmfnepal.org/

Grameen Bank http://www.grameen-info.org/

National Bank for Agriculture and Rural Development (NABARD) http://www.nabard.org/

Pakistan Microfinance Network http://www.pmn.org.pk/
Pakistan Poverty Alleviation Fund (PPAF)

http://www.ppaf.org.pk/default.htm

Palli Karma-Sahayak Foundation (PKSF) http://www.pksf-bd.org/

Sa Dhan: Association of Community Development Finance Institutions http://www.sa-dhan.org/

South Asian Microfinance Portal http://www.microfinancesouthasia.net/

20. Where can I learn more about microfinance in North America?
Regional Organizations

Accion USA http://www.accionusa.org/default.asp


Association for Enterprise Opportunity

http://www.microenterpriseworks.org/

Community Development Credit Unions http://www.natfed.org/i4a/pages/index.cfm?pageid=1

Community Reinvestment Act http://www.ffiec.gov/cra/default.htm

Shorebank http://www.sbk.com/livesite/main/

Small Business Association http://www.sba.gov/

United States Treasury Department Community Development Financial Institutions Fund http://www.cdfifund.gov/

Regional Documents

Replicating Microfinance in the United States http://www.press.jhu.edu/books/title_pages/2269.html

21. Where can I learn more about microfinance in Latin America and the Caribbean?


Regional Organizations
Accion International http://www.accion.org/default.asp

Asociacion de Instituciones Financieras para el Desarrollo Rural http://www.finrural-bo.org/

El Portal de la Finanzas populares en Mexico http://finanzaspopulares.ht.st/

The Foundation for International Community Assistance (FINCA) http://villagebanking.org/where/country.php3?cid=2

Inter-American Development Bank http://www.iadb.org/topics/mi.cfm

Inter-American Development Bank http://search.iadb.org/search.asp?

Katalysis Partnership http://www.katalysis.org/

Latin American Network Information Center (search on “microfinance”): http://www.google.com/u/lanic?q=microfinance&sa=Go

ProMujer http://www.promujer.org/

Red Financiera Rural http://www.rfr.org.ec/
Sistema de Informacion sobre la Microempresa en America Central

http://www.sipromicro.org/

Regional Documents

Benchmarking Latin American Microfinance http://www.mixmbb.org/BenchmarkingLAC-en.pdf


Microfinance: From Village to Wall Street, Jansson, T (IADB) http://microfinancegateway.org/content/article/detail/3145

Major Global Micro-Finance Institutions

Accion International http://www.accion.org/

Grameen Bank http://www.grameen.com/

Women's World Banking http://www.swwb.org/

Opportunity International http://www.opportunity.org/

FINCA International http://www.villagebanking.org/

Calmeadow http://www.calmeadow.com/

Source: Micro finance gateway

A Short Glimpses of Micro Finance Sector of Nepal

Micro-Finance in Nepal

Introduction

Nepal is one of the poorest country in the world and the poorest in the South Asia region. Its poverty reduction rate is low. The main reasons for this low poverty reduction rate are: (i) low per capital income, (ii) concentrated urban growth, and (iii) high population growth rate. Out of a population of 23 million, 38% are in below the poverty line. Most of the poor people live in rural areas and have little opportunity. Micro-finance could help poor people who have no collateral, but a willingness to work and a desire to do some business activities from which he/she will acquire employment as well as income.

Although many programmes have been implemented for poverty alleviation in Nepal, only micro-finance programs are seen as a poor targeted and rural based.

InNepalagriculture based co-operatives were initiated in the 1950s as a first step in micro-finance. Poverty alleviation rural based programs were initiated through the small farmers development program (SFDP) on a pilot test basis in 1975 by the ADB/N. The success of the pilot tests in Dhanusa and Nuwakot districts encouraged policy makers to expand formal rural based micro-finance programs.

The SFDP is now being transformed into several autonomous, self-help organizations called Small Farmers Cooperatives Limited (SFCLs), which are managed by farmers themselves. Other micro-finance development programs, such as Priority Sector Lending Program (PSLP), Intensive Banking Programme (IBP), Production Credit for Rural Woman (MCPW) and Rural Self-Reliant Fund (RSF) have been implemented. After studying the pros and cons of various microfinance development programs government began to rethink the delivery mechanisms of micro-finance.

In 1992, government set-up two Grameen Bikash Banks as a replication of the Bangladesh Grameen model of micro-finance delivery. Government also created a situation to encourage participation in the micro-finance by the private sector. Subsequently Nirdhan, CSD, Chhimek and other organisations came into existence. RMDC was also established to support micro-finance institutions by giving wholesale credit, initiating training and other necessary support to the MFIs. Some Government directed Programs (TLDP, Bishweshwor with poor, PAPWT, Community Ground water project, etc.) have been implemented in coordination with NRB.
MFIs are dependent on small savings from group members. As a definition Micro-finance is, as a part of development finance, rural or urban, targeted towards specific groups of people, male or female, falling in the lower bracket of society. Financial services include savings, credit and other services such as micro money transfer and micro-insurance. This service is differentiated by types of service employment and income orientated objectives, target group, target community, target area and credit at home.

In the past decade, micro-finance has been recognized as a particularly effective development intervention for three basic reasons:

The services provided can be targeted specifically at the poor and poorest of the poor.

These services can make a significant contribution to the socio-economic status of the targeted community.

The institutions that deliver these services can develop, within a few years, into sustainable organizations with steadily growing outreach.

In this context, it is important to make a couple of distinctions:
Micro-finance is more than the provision of credit. It involves the provision of other financial services (most usually savings and insurance) and recognizing that even the poor have a variety of needs, not just credit.

Securing sustainable access to micro-finances for low-income communities involves building (or reforming) micro-finance institutions- not just the delivery of time-bound micro-finance programs (such as offering short-term revolving funds)

The Regulatory Status

Microcredit institutions are regulated by various laws. These are: Nepal Rastra Bank Act (2002), Agriculture Development Act (1967), Cooperative Act (1972), Finance Company Act (1985), Development bank act 1996 Social Welfare Act (1991), Company Act (1947), Financial Intermediary Act (1998) and Insurance Act. It appears to be over regulated but in reality the situation is just the opposite. There is some difficulty to regulate all micro-credit institutions because there are many MFIs established under different acts doing micro-finance activities. The ultimate responsibility to develop, regulate, monitor and supervise is of NRB. Recently, on February 24, 2003, NRB issued regulations for the development banks which are engaged in micro-finance, as a guide line to develop MFIs activities.

Challenges in Micro-Credit Delivery in Nepal

Nepal has a varied topography at varied development stages, a mix of different cultures and different ethnic groups, which challenges the successful delivery of micro-finance. The major challenges are:

Formulating a micro-credit delivery mechanism that is better suited to the people in hills and mountains.
Successfully extending the outreach to the hills and mountains.
Redesigning existing programs of the formal MFIs to better target the poorest.
Unsustainable delivery mechanisms of government initiated MFIs and programs.

Evolution of Micro-Finance

The earliest initiatives for establishing micro-finance inNepaldate back to the 1950s, when the first credit cooperatives were established. For providing rural financial services, this was the first step. These cooperatives primarily intended to provide credit only to the agriculture sector. The next milestone was SFDP in 1975 within ADB/N. This program covers the entire country and aims to organize farmers into small groups to provide credit without collateral.
In 1981, NRB introduced the Intensive Banking Program (IBP) and compelled to the commercial bank to finance at least 7 percent on the priority sector, which was further increased to 12 percent in 1990. Now this compulsion is being phased out gradually.
In 1992, Grammen Bikash Banks were initiated by the government sector, crossing a milestone in rural micro-financing in Nepal and NGOs started grameen banking activities in certain areas.

Credit co-operatives were established in the 1950s.
Co-operative bank was established in 1963
Small farmer groups were established under SFDP (1970s)
SFDP was established under ADB/N (1975)
Commercial banks began to follow priority sector lending directives (1974)
The IBP program tries to involve commercial banks in micro-credit (1981)
Gender based micro-credit - PCRW (1982)
Gender programs refined - MCPW (1994)
Replication of Grameen Banking model (1992)
Co-operative act was established to support the credit cooperatives (1992)
Government-run MF programs - Bisheswor with the Poor, Women's Awareness program, government peace movement, etc.

The MF Sector in Nepal

Within Nepal there are a wide range of institutions active in the micro-finance sector, each with its own way of going about the task of making financial services accessible to the poor. Some writers distinguish between the so-called informal and formal sectors, but given that many of the informal organizations are in fact registered societies, the preferred terms to use are community-based sector and institutional sector.

The Institutional Sector

Nepal Rastra Bank (NRB)

NRB is a central bank and an apex institution of the financial system. It has placed various efforts to develop the micro-finance system inNepal. It introduced the priority sector (small sector) lending program in 1975 and the intensive banking program in 1981. Further, in 1992, NRB participated in equity and management to develop the Grameen Banking system by introducing regional rural banks as a replication of Bangladesh Grameen Banking model. NRB plays a vital role to develop the micro-finance system inNepalthrough introducing policy, systems and institutions as well.

Micro-finance Wholesale Apex Institutions

RSRF (Rural Self Reliance Fund)

In 1990, HMG/N introduced a fund of NRs. 10 million to provide a wholesale fund for small cooperatives and rural based NGOs to on lend to micro entrepreneurs. Further in 1999, government provided additional support of NRs. 10 million to the RSRF. Since the beginning, the fund has been handled by NRB. Up to mid July 2002, RSRF sanctioned loans to 48 NGOs and 129 cooperatives amounting to NRs. 18.15 million and 34.21 million respectively.

RMDC

Under the financial support of ADB, Manila, NRB, banks and financial institutions together injected equity to form the micro-finance apex institution Rural Micro-Finance Development Centre' (RMDC), incorporated in 1998 mainly to extend wholesale fund to the micro-finance institutions. As of mid July 2002, RMDC had approved NRs. 204.8 million in loans to 17 MFIs and disbursed NRs. 107.8 million. Its mandate includes capacity building for MFIs and ultimate borrowers in addition to providing a fund for on lending to them.

Commercial Banks (CB)

According to the NRB directive, commercial banks need to extend at least 3 percent of their total loan outstanding to the deprived sector. CBs are extending the 3 percent fund in equity and also providing wholesale loans to MFIs. At present, 25 commercial banks are extending credit to the deprived sector, amounting to NRs. 3482.6 million.

Small Farmer Development Bank (SFDB)

SFDB was established in 2002 under the development bank act of 1996 to provide wholesale funds to Small Farmer Co-operatives Ltd. (SFCLs). SFCLs were developed by the SFDP of ADB/N to make groups of small farmers self-reliant and sustained. Until now, the total number of SFCLs affiliated with the SFDB is 35 and the total number of groups within the SFCL is 3,434. The total loans disbursed to the group members amounts to NRs 25.4 million.

Development Banks

Some development banks formed under the development bank act 1996 are implementing micro-finance activities in rural areas. Prior to becoming development banks, some institutions were active as NGOs in the field of social development, as well as in micro-finance. Among these banks, 5 are regional rural development banks in the government sector and 6 are micro finance development banks established by private sector.

The Community Based Sector

FINGO (Financial Intermediary Non-government Organization)

Normally, NGOs inNepal(at least those registered under the Societies Act) have not been entitled to undertake profit-oriented activities, such as financial intermediation. However, the rapidly growing engagement of NGOs in social development has created a need for extending some basic financial services such as micro-finance services. To address the lack of institutions providing MF services in many areas of the country, the Central Bank of Nepal (NRB) has provided a mechanism by which selected NGOs can engage in financial intermediation activities. These activities are defined as the borrowing and on-lending of funds, but do not include direct deposit taking from the public. Currently, a couple of dozen NGOs have already been licensed by NRB. The last session of parliament approved changes in the Financial Intermediary Act of 1998, which now allows FINGOs to collect savings from the members of groups. Those NGOs that are operating in financial services transactions and opting for an NRB license are referred to as FINGOs.
As a replicator of Grameen Model, some NGOs were established to extend credit facility to the rural poor: Nirdhan (1991), CSD (1991), Chhimek, Deprosc (1994). In 1996, the development bank act came into existence and the above-mentioned NGOs became development banks. Since the financial intermediary act was implemented in 1998, 37 NGOs have received permission to extend credit and collect savings from the rural poor in group-based activities. The main objectives of these NGOs are to extend micro credit activities and help towards raising the living standard of the poor.

Saving and Credit Co-operatives

SACCOS are member owned, controlled and capitalized organizations, which provide financial services to members. There are more than 2,300 SACCOS registered with the Co-operative Department in Nepaland approximately 400 of these are a member of the national federation, NEFSCUN.Savings and Credit Groups
There are tens of thousands of unregistered SCGs in Nepals, some of which are quite large even though they are not registered either as NGOs or co-operatives. The vast majority of these SCGS grew out of assorted development initiatives (literacy programs, water and forestry user groups, mother and child programs, etc.) into which a savings component had been introduced, if only to strengthen the likelihood that the group would continue to meet and be active, after the specific program intervention had been competed. Given the limited prospects of such smaller groups, and the problems that promoting agencies face in maintaining outreach to large numbers of scattered, small groups, considerable attention is being paid nowadays to mechanisms for federating and institutionalizing these groups.

Traditional Savings and Credit Groups

Nepal has a long history in the operation of traditional savings and credit associations, often referred to in the literature as a rotating savings and credit associations (ROSCAs), but known locally as Dhukuti or similar terms. These tend to be non-registered, but quite formally structured in terms of membership rights and obligations, etc.
Outreach
InNepal, traditionally there were many programs developed by government and government agencies in the formal micro-finance sector and by private organizations in the private and informal sector.

In rural financing and especially in providing microfinance services there are some major issues, which have emerged from the operation of existing MFIs inNepal. Those issues are the following:

Dominance of the government and its agencies in micro-credit.
Need for restructuring and privatize the GBB to reduce the public sector dominance.
Limited outreach in the hills areas.
Diffused or not concentrated focus.
Role of INGOs, MFIs, Apex wholesale institutions.
Sustainability and interest rate.

Conclusion

During the last decade of the 20th century it has become accepted that micro-finance is one of the most significant contributors for poverty alleviation. In Nepal, although the poverty reduction rate is slow, if a proper model is used the hill and Terai regions the standard of living could be raised very quickly. The diversity of regulatory acts shows that it is necessary to cater to all MFIs under one act for licensing, regulating and supervising and needs to make National Policy in micro finance. InNepal, experience shows that private sector managed MFIs are better off than government owned MFIs. So, it has become necessary to handover all Grameen Banks to the experts of micro-finance.

The micro-financing area inNepal includes largely participation of private sector. So the role of government, NRB and micro-financer should be defined as early as possible. Now our ultimate challenge is poverty. This is the challenge of the government and private sector. For the fair implementation of micro-finance inNepal, the government’s role should be as a guardian and referee so that all players can play fairly

Courtsy: CMF

New Initiations on financing Renewable Energy Technologies

Location: Nepal
Project’s Aim: Stimulate and facilitate micro financing of biogas plants
Technical Answer: Capacity building

The project has been recognized as one of the best practice project in micro financing of RETs by Wuppertal Institute for Climate, Environment and Energy (WISIONS), Germany.
http://www.wisions.net/Download-Dateien/1st_PREP_issue_06.pdf

Only 150,000 of Nepal’s potential 1.9 million biogas plants have been installed; most of these installations are in relatively affluent areas. High transportation costs to remote scattered villages increase system costs. This and the decreasing government subsidy means that rural communities have to put in more cash for biogas installation. However, these subsistence-based rural communities lack disposable income to pay upfront costs of plant construction. Therefore, there is immense demand for affordable means of credit from such communities. Access to credit plays a vital role in bringing biogas within the economic access of these communities.

“Capacity Building for Micro financing of Renewable Energy Technologies” is implemented by Winrock International in collaboration with the governmental Alternative Energy Promotion Center (AEPC) and the Biogas Sector Partnership, Nepal (BSP). The project is designed to expand the installation and use of biogas plants by increasing access to microfinance for lower-income purchasers.

The partners have designated roles: AEPC promotes various renewable energy technologies (RETs), provides subsidy, and manages a revolving fund of 2.5 million Euros to provide wholesale loans to MFIs to on-lend to farmers for biogas installation. BSP manages the biogas programme, is responsible for research, promotion and quality control. Winrock works to strengthen both the demand and the supply aspects of financing biogas.

BENEFITS

A single biogas unit is estimated to directly help conserve 3 tons of fuel wood annually. On this basis, the 2,500 biogas plants installed with project support are saving around 67 hectares of forest annually. 75 per cent of the biogas plants are connected to toilets, providing health benefits related to better hygiene practices. Furthermore, biogas reduces harmful indoor air pollution.

Moreover, each biogas plant prevents an average 4.6 tons of CO2e from being released into the atmosphere annually. The plants installed have reduced greenhouse gas emissions by over 11,500 tons of CO2e.

As a result of this project, 56 mason jobs were created through the increased demand for biogas plants among MFI clients.

Interested MFIs including dairy cooperatives and forest user groups are now actively promoting biogas plants among their constituents due to the direct link between cattle raising (and associated income generation) and availability of raw materials for biogas generation and the link between biogas plants and forest conservation.

SUSTAINABILITY

The project emphasises mobilisation of commercial sources of financing and supports capacity building and awareness creation. Once the project can provide this support to a critical mass of MFIs (around 300), biogas micro financing will take off by itself. Already many MFIs have adopted biogas as a suitable loan product. With declining government subsidy, demand for credit will increase.

TECHNOLOGY

Biogas is a proven technology in Nepal with over 150,000 plants already installed and a 97 per cent operational success rate.

FINANCIAL ISSUES

The 2005 project target was to facilitate 1,500 biogas loans amounting to USD 200,000, leveraging USD 500,000 in total investment. The project has exceeded this target by facilitating construction of 1,572 biogas plants through micro credit.

The project has contributed to increased understanding among MFIs and companies of biogas technology and its financing. The number of micro-credit financed biogas plants will increase in the coming years when commercial banks and MFIs move aggressively into this sector. Some commercial banks have already agreed to provide wholesale loans to MFIs for biogas financing.

Past experiences indicate a time delay between capacity building activities and the resultant outcomes. Therefore, it is very difficult to carry out a comprehensive financial input and output analyses of the project at this stage. Through the involvement of two full time professionals, the project, in its two years, has enabled USD 333,000 investment as MFI loans, leveraging USD 833,000 in total investment. Training programmes have been conducted on a cost-share basis with MFIs and partner organisations mobilising over USD 50,000 in additional financial resources.

OBSTACLES

Major problems identified were lack of awareness about RET micro-financing among MFIs, limited source of wholesale financing and inadequate functional linkage between MFIs and energy companies. The project is designed to address these problems and has a three-pronged approach i.e. capacity building of MFIs, linkage facilitation between various stakeholders and lobbying for favourable policy environment.

A number of beneficiaries of the first phase of the training programme were visited to determine progress and to identify barriers and constraints in financing biogas. A platform has been provided for successful MFIs to share experiences.

REPLICABILITY

Poor households living in rural areas are deprived from RET benefits due to lack of disposable income. They cannot pay the cost of systems upfront and need affordable credit. So there is a universal demand for credit, which MFIs can provide cost-effectively.

This programme can be replicated by other MFIs and for other RET technologies since the project mobilises AEPC and other commercial sources of funds and promotes the establishment of competent institutions in this sector through various capacity building initiatives. Training materials and programmes are already developed and tested. So this can be replicated with marginal incremental cost in the future.

Based on the success of micro-financing biogas, MFIs were also trained on micro-financing solar home systems, improved water mills and solar tukis (WLED based solar lamps). A number of MFIs have already started financing such systems.