Micro-credit: The way forward

Bangladesh is widely considered to be the "natural home" of microfinance which has helped boost the country's image abroad. Looking forward, there are gaps in the market that micro-finance institutions (MFIs) could focus on and there are gaps in the policy framework which the government of Bangladesh needs to address -- issues that I would like to reflect upon here.

MFIs in Bangladesh have made remarkable progress in reducing donor dependence. A recent World Bank study shows that a cross-section of micro-finance institutions are profitable even after adjusting for various kinds of subsidies they have received. Another study done this year of the financial performance of 143 leading micro-finance institutions throughout South Asia, including 35 in Bangladesh that have most of the outreach, showed that 96 percent of micro-credit borrowers in Bangladesh receive services from a profitable microfinance institution. In India the equivalent percentage is 75 percent, and in Pakistan 42 percent.

A recent World Bank study shows that even very small micro-finance programs are profitable. The main sources of revolving loan funds in 2005 are member savings and the capital that micro-finance institutions have been able to build up over time, much of it from retained earnings. These surpluses are used to finance access to new members and to cross-subsidize small loans for the poorest. Average interest rates charged by micro-finance institutions have also fallen over the past year and it will be important to ensure that this reduction in rates, and therefore in micro-credit surpluses, does not squeeze out access by the poorest. At the same time, MFIs are seeking greater access to commercial sources of funds, both locally and internationally, though such opportunities are still too few and only growing slowly.

There has been a healthy debate on the extent that micro-credit improves the lives of the poor. On the one hand, to the extent that micro-finance institutions receive a subsidy, is that the best use of scarce public resources? On the other hand, when there are no subsidies, does micro-finance reach the very poor? Much of the debate has focused on the extent that micro-credit contributes to reducing income poverty. There has been relatively little emphasis on its impact in reducing the vulnerability of poor people to various types of seasonal and life-cycle shocks. Giving loans to poor people has been shown to smooth consumption, thereby limiting the amount of harm done in lean seasons or natural disasters.

For instance, research by Jonathan Morduch of New York University shows that consumption variability is approximately 50 percent less for Grameen Bank and BRAC borrowers, compared to comparable non-borrowers. We also know that micro-credit has contributed positively to non-income dimensions of poverty, such as children's education and nutritional status, both through the impact of increased incomes and the social mobilization messages delivered during group meetings.

For instance, nearly all girls in Grameen client households received schooling compared to 60 percent of girls in non-client households. Fewer BRAC clients suffer from severe malnutrition compared to a comparable group of non-clients. Moreover, there is evidence that micro-credit in Bangladesh has contributed to female empowerment through, for example, greater decision-making power within the household, and enhanced mobility and participation in local elections. However, there is still room for improvement both in documenting and enhancing this impact, particularly for the hard-core poor and for "graduate" borrowers who require greater amounts of credit.

Turning to financial accountability and transparency issues we find there is growing interest in the Bangladesh micro-finance sector in sharing financial information widely in order to benchmark one's institution against other organizations, or to gain greater access to commercial funding. Around 35 Bangladeshi MFIs now provide data to the Microfinance Information Exchange, compared to only five in 2003. However, more can be done in improving financial accountability and transparency, such as posting audit reports publicly, improving the quality of these audits, and strengthening accounting standards.

Grameen Bank, one of the oldest micro-finance institutions in Bangladesh, is a good example of how the industry is changing and growing. In 2000, Grameen Bank, began to consider how it could introduce greater client choice while ensuring credit discipline and controlling costs. This led to the emergence of Grameen II in 2002, offering deposit services to the general public, greatly expanding the range of deposit services offered to members, including the very popular "Grameen Pension Savings."

Grameen II has introduced a wider range of loan contracts, with variable terms and repayment schedules, which has proved popular with its clients. Grameen II also makes scholarships to students, loans for higher education, and has reached out to the poorest people with no-interest loans for beggars. These changes in Grameen Bank's programs have resulted in sharp growth in portfolio size and membership since 2002. By the end of 2005 the number of active clients had grown to over five million from just over three million in 2003. The popular savings products have boosted total deposits from $163 million in 2002 to $450 million by the end of 2005.

As these changes in the micro-finance industry unfold, a more inclusive financial sector will emerge with more people than ever before having access to financial services, including a broader range of services better suited to their needs. This will require that the government reconsider its role, not to own and control micro-finance service providers or to provide services directly, but to provide an appropriate regulatory environment, setting standards that promote public confidence and protect the interests of poor people while not stifling the growth and innovation that increasingly characterizes the industry.

The proposed new micro-finance regulatory framework being considered by the government can go some way towards achieving this. Among the innovative aspects of the draft regulatory framework is the proposal to create an independent micro-finance regulatory commission and a provision to create micro-credit banks. Micro-finance banking would allow MFIs to accept deposits from the public, and would then allow deposits to be channeled back to rural areas in the form of micro-credit. At present, rural deposits mopped up by the Nationalized Commercial Banks (NCBs) are transferred to urban areas where they are loaned out to wealthy clients in the form of big loans whose repayment rates are lower than micro-credit.

In order to create a level playing field it is essential that Government operated micro-finance programs are also brought under the provision of this law. At the same time, it is important that the government consider altering aspects of the 1983 Grameen Bank Ordinance in order to enhance Grameen Bank's operational autonomy and maintain its competitive edge. This would include allowing Grameen Bank to do business in urban areas, increasing the ownership share of the borrowers, reducing the number of directors nominated by government, election of the chairman by the directors rather than being appointed by government, and making it optional for Grameen Bank to have a government guarantee when issuing bonds and debentures.

While government works to strengthen the enabling environment for micro-finance, MFIs can also strengthen the services they provide to their clients. For instance successful experiments that provide micro-credit to the poorest ought to be scaled up and donor financing may well be necessary for this. Lessons from PKSF's partnership with nineteen MFIs on different ways of providing micro-finance to the extreme poor need to be disseminated widely. Moreover, lessons from MFIs such as the Integrated Development Foundation (IDF) which provide micro-finance in geographically hard to reach areas such as the Chittagong Hill Tracts also need to be learnt so that there is greater regional balance in access to micro-credit.

MFIs that provide micro-credit also ought to continue judiciously with their entry into providing larger loans. Many MFIs have already ventured into this market, though with a few exceptions, the number of larger borrowers is still relatively small. While there is a temptation to upscale these programs rapidly from a public policy standpoint, given the potential growth-generating impact, the current cautious expansion strategy is probably the right one. Providing larger loans has its benefits but it also involves considerable risks, as there are a limited number of former micro-credit borrows who want to "graduate" into this market and new wealthier clients do not have a credit history with the lender and are less likely to be socially pressured into repaying. The experience of Buro Tangail shows that offering flexible financial services attracts clients, who are prepared to pay a higher price for the additional services. Buro Tangail's loan portfolio grew by around 65 percent each year over the 2000s despite charging higher than average lending rates. While new services are developed it is essential for MFIs to remain cost-effective; the Association for Social Advancement's (ASA) highly cost-effective micro-credit delivery model is another reason why Bangladesh's micro-credit industry is acclaimed globally.

In short, Bangladesh is the current world leader in micro-credit. In order to retain this standing, both government and MFIs need to remain at the cutting edge. The government needs to provide an enabling regulatory framework (including the provision for micro-credit banks) and ensure the independence of key institutions like the Grameen Bank. MFIs need to do their part by sharing financial and program information widely, diversifying their services to cater to different market segments, and remaining cost-effective.

Praful C Patel is South Asia Regional Vice-President, the World Bank.