#02 Business
Oliver Schmidt

Who Uses Microfinance and Where do They get it?

The microfinance customer: low income and rural

Maureen (24) and Charles (28) have been married for seven years. They have two children ages six and four. Maureen is pregnant (in her fourth month) for the fourth time. Her third child was stillborn in the sixth month. Charles owns a small plot of where his wife grows matooke (plantain), maize and vegetables. Charles works as a day laborer on neighboring farms too large for one man or woman to cultivate alone.

Miriam (45), Maureen's mother, recently lost her husband. She lives with her two younger daughters on their small plot of land. One daughter is in secondary school, the other has dropped out to work the land. In addition to the food they grow themselves, Miriam also sells chapattis (pancakes) at the side of the road.

Josephine (29) and Martin (34) have managed their farm well. They were able to expand both their land and the volume of matooke, maize, and coffee grown there. They also keep cattle. They bought a pick-up, which fulfils the transport needs for both Martin's farm and Josephine's produce trade at the major market in town. Martin relies on his younger son and on day laborers like his neighbor Charles to do the farm work. The elder son is studying in the capital.

The overwhelming majority of potential microfinance customers live in rural areas where agriculture is their major source of income. In most rural areas in Asia, Africa and South America, population growth has reduced the amount of cultivable land available to each household. Furthermore, unsustainable cultivation methods and deforestation have resulted in badly deteriorated soil quality in many regions, particularly in South Asia and West Africa. Most of these rural areas remain remote, unconnected to the electricity grid, though many now have access to mobile phone networks at least. Roads and other market access routes are of poor quality.

Though most of the 100-150 million primarily female microfinance customers worldwide, about two-thirds of whom reside in South Asia, live in rural areas,[1] the majority of the rural population remains excluded from formal (i.e. financial institutions [FIs], such as banks, regulated by a central bank) and semi-formal (i.e. cooperative and other microfinance institutions [MFIs] not regulated by a central bank) financial services.[2] Leaving aside the factor of low monetization which restricts financial access in some areas, rural populations do use a variety of financial instruments: They save, they lend and borrow, they send money, and they attempt to safeguard against risks, e.g. insure.[3]

A brief overview of financial life in rural households

Let us consider the example of Maureen and Charles and their two children.[1] They are probably able to feed themselves off their own land. Their or communal land will also provide most of the materials they need to create shelter, sanitary facilities and to do the daily cooking for free. Improved shelter and sanitation will require some money, though, as will access to improved drinking water.

They also need money to provide health care, particularly during pregnancy and early childhood. They have school expenses for their eldest child. These include pens, notebooks, a school uniform and, as few developing countries offer (de facto) free education, school fees. They also need some money to maintain their social network, i.e. contribute to health care, schooling, starting a new household (weddings), family expansion (childbirth) and the funerals of neighbors and relatives. They will have met most of the recent funeral costs for Maureen's father and are contributing something to the health care and schooling costs for Maureen's siblings and maybe to health care for Maureen's mother Miriam if she can't earn enough herself.

Maureen and Charles generate money from his work as a day laborer and her sale of some of the land's harvest. In their extended family, Miriam earns money selling chapattis and some of the harvest from her land (which is being cultivated by her second daughter).

With regard to expenses, all the financial demands on this extended family involve larger sums. Schooling expenses are due two to three times a year (depending on the system of school terms) at pre-determined points in time. Expenses for health care and social obligations occur in irregular intervals. The 'Western' reader may assume that health care is the most pressing issue and that social obligations could be met according to available means. But observations confirm the opposite is true. Social pressure is felt more strongly and takes precedence; indeed being at odds with the social network is a considerable threat to wellbeing, particularly in low-income segments and traditionally collective cultures. Health care, on the other hand, is an individual issue that can be postponed (one might even entertain the hypothesis that postponing health care is a particularly human trait). Moreover, in the absence of detailed knowledge, many health risks and issues are not recognized as such. Hence, rather than regularly spending small amounts on health care, such as prenatal diagnostics, clean water and other hygiene factors, mechanical malaria prevention (e.g. mosquito nets) etc., money is spent on health care only when disaster strikes. Examples include heavy fever or other outbreaks of disease that lay a person low and accidents involving severe fractures or deep wounds. These are, obviously, extremely expensive to treat, and the lack of regular health care often further increases the costs. Moreover, such events mean that income is lost while the sick person is unable to work.

With regard to income, most is seasonal and uncertain. Charles only earns on the days he is hired. These are determined by the seasons of his employers' crops, i.e. plowing, planting, weeding and harvesting of matooke, maize and coffee. Outside of regular seasonal activities, opportunities for a day's work are scarce. Similarly most of the crops from Maureen's and Miriam's (which includes Maureen's younger sister) lands are sold seasonally. In addition to pre-harvest risks like too much or too little rain, pests and insects, prices at harvest time are also low. In contrast to Josephine and Martin, who control some of their market access by owning their own transport and trade facilities, Maureen and Miriam are powerless against these price risks.

Miriam's chapatti business provides the most regular income. Every day she is successful in selling her wares means some revenue. As long as she understands her market well enough, there is little risk, because the ingredients are neither particularly perishable nor difficult to purchase, giving her low input cost volatility. Additionally the chapattis are well suited to create some demand of their own – freshly made pancakes are popular anywhere in the world.

Microfinance loan products

Microfinance loan products are geared towards financing micro-entrepreneurs and micro-businesses, like Miriam and her chapatti sales respectively. The most widespread microfinance loan product is modeled after the approach developed by the Grameen bank in the 1970s. Here borrowers form a joint liability group (JLG) of five. The five members take turns receiving loans of 52 weeks tenure; all five are at any time jointly liable for timely repayment should the respective borrower fail to repay. The MFI clusters four to six JLGs groups, i.e. 20 to 30 members, into a center. The MFI field officer meets with the center weekly. At the center meeting, loan applications are discussed and approved by all center members, approved loans are disbursed, repayments collected and other issues addressed as needed (absent members charged a fine, defaulting borrowers questioned etc.). 9 of the 10 largest MFIs worldwide apply a group lending methodology (table 1a).

table 1a

Most of them have evolved since the 1990s by 'replicating' the Grameen model and varying its features, i.e. group size, repayment rhythm, loan sequencing and tenure, savings component.

Group-based financial instruments were not invented by microfinance institutions; they have been around for a very long time. Probably almost everybody living in a rural area in a low-income country is a member of one or the other of these informal groups. The most common form is the 'merry-go-round', known as tontine in French-speaking Africa. The technical term is 'rotating savings and credit association' (ROSCA). In this group, each member contributes a fixed amount at every meeting – the rhythm is agreed ahead of time (daily, weekly, monthly) – and the 'pot' is received by members in a fixed order. Hence, each member receives a 'lump sum' once during the ROSCA cycle. Variations distribute the pot at random, or auction it off. In the latter version, the price paid by the successful bidder is distributed as 'interest' to all members.

MFIs have improved these informal, group-based financial instruments in terms of reliability and loan volume. The resulting loan products are useful for creating and expanding businesses that have high turn-over and produce returns pretty quickly, like Miriam's chapatti sales, any petty trade, small shops, and some forms of husbandry, e.g. keeping buffalos for milk (such as in India where a robust dairy infrastructure is available) or chickens for eggs.

However, these loan products are not suitable for financing farming which has low turnover and only produces income seasonally. Some MFIs, notably cooperatives in Uganda or BASIX in India, offer individual loans against physical collateral, e. g. land titles, with a grace period of four to eight weeks which might finance crop farming. But only if the farm has a certain size and business-orientation, and usually only if the total household income comes from a variety of sources. Josephine and Martin, for example, could access such loans, because their farm is large, grows a variety of crops in addition to cattle, and they also have income from trade business. For smallholder farmers like Maureen and Charles, such loans are usually not accessible because their farm is too small, hence perceived as too risky by MFIs, and such farmers do not generally have formal land titles.

From microcredit to microsavings and beyond

The challenge of microfinance is to develop products that can finance social obligations, health and schooling expenditures for households such as that of Maureen and Charles and of Miriam and her daughters. Such products must be built on managing a household's cash flow so that some of the income peak is transferred to the points of peak expenditure. Savings are the backbone of such liquidity management products, and are combined with loan and/or insurance facilities. Indeed MF practitioners today agree that savings are the most important financial instrument because everybody can, wants to and does save, but only some need loans.[5] However, savings are subject to strong regulatory requirements. That is why seven of the ten largest MFIs in terms of number of depositors differ from the largest MFIs in terms of number of active borrowers (table 1b). The three MFIs featured on both lists are based in Bangladesh, but now operate in many countries; they serve about 16.6m active borrowers compared to 23m depositors.

table 1b

Interestingly, the numbers of depositors and borrowers in both top groups are nearly the same, about 41 million. Moreover, if China's Postbank is not included, the deposit portfolio nearly 'covers' the loan portfolio. Thus, savings are not only sought after by low-income households; they are also a viable business proposition for MFIs. However, because of the regulatory framework (mainly but not exclusively in India), credit-led MFIs have evolved organizational cultures and operations substantially different from saving-led MFIs. The latter are rooted in FIs regulated by a central bank, the former are rooted in non-financial NGOs. Note also that the average loan size of the ten largest deposit MFIs is many times higher than the average loan size of the ten largest lending MFIs. This leads to the conclusion that the challenge of microfinance is also to create a business model or a business environment that offers access to the full array of financial instruments and products for the same target group.[6] The Bangladesh-based MFIs may, once more, lead the way.


[1] In Africa, the proportion of urban and semi-urban customers is relatively higher than in Asia (because of transaction costs). Following worldwide urbanization trends – 2008 marked the first time in history more people lived in cities than in rural areas – urban microfinance will gain relevance in future.

[2] The number of microfinance customers is based on the data available online from MixMarket and The MicroCredit Summit Campaign. A detailed Financial Access 2009 Report was published by the CGAP, available at www.cgap.org/p/site/c/template.rc/1.9.38735/ [27. Oct. 2010].

[3] For further details and empirical findings, see Collins, D. /Morduch J. /Rutherford S. / Ruthven O. (2009): Portfolios of the Poor; Princeton, New Jersey.

[4] These three cases are fictional and were taken from the teaching materials for Uganda's Mountains of the Moon University (www.mmu.ac.ug) 'Rural Microfinance' courses. For a selection of real-life cases, see www.portfoliosofthepoor.com.

[5] See Rutherford, S. (1999): The Poor and their Money, Institute for Development Policy and Management, University of Manchester

[6] Note that we have not discussed money transfers here. Increasingly development practitioners agree that robust money transfer systems are an important element of a pro-poor financial system, in part driven by the world's urbanization trend (see footnote no. 1). Many MFIs are experimenting with money transfer services. The most relevant changes in this area are driven by mobile phone companies, though, such as in East Africa where the respective regulatory framework is favorable.