Challenges And Solutions

2

Challenges to the Field and Solutions:
Overindebtedness, Client Dropouts,
Unethical Collection Practices,
Exorbitant Interest Rates, Mission Drift,
Poor Governance Structures, and More
Anton Simanowitz

When years turn our vision dim and grey, we shall still see the beauty
in the tired wrinkles of our face; we will find comfort in the wisdom and
knowledge of the fact that we did all that we could in our power to
achieve our goals.
Equity Bank, Kenya—Part of internal inspiration statement,
used to give direction and mission to employees.

At the core of microfinance is a concern for people. About 1 billion people start
their day uncertain about whether they will get enough food that day to satisfy
their hunger, while a further 1.5 billion people have the basics, but struggle to
improve their conditions, and are always aware that they are one crisis away
from the daily battle that faces the poorest people.1
My starting point is the needs of clients and potential clients—a perspective
that is unfortunately heard less and less as microfinance focuses on building
sustainable institutions rather than sustainable clients. I argue that the starting
point needs to be an understanding of the experiences, challenges, and needs of
the different groups of people an MFI serves. This approach allows for prod-
ucts and services to be designed and delivered that are appropriate to their
needs, and for processes and systems to be refined so that they are efficient and
effective from the client’s point of view.

53

54 NEW PATHWAYS OUT OF POVERTY

This chapter looks at how the ideals of microfinance can be achieved, and
the factors that inhibit it from achieving its potential. In writing this I have con-
sulted with many people,2 and almost without exception, the social value of
microfinance is highlighted as the foundation. Even where delivered through
for-profit, commercially focused institutions, ultimately microfinance is seen as
a means to an end. Few would see profit as their sole reason for working in
microfinance.
The first section of the chapter addresses some of the more visible and prac-
tical challenges highlighted by crises in some markets. Clients experience these
challenges directly in the quality and scope of services they receive, how they are
treated by the MFIs’ staff, and ultimately in what value or harm is created by
using the services.
While some people see the recent crises as isolated incidents, the majority
feel that fundamental lessons need to be learned. Overall, a broad range of
microfinance actors reject media suggestions that perhaps microfinance itself is
a flawed idea, but highlight the need for the microfinance community to reex-
amine assumptions and find ways to increase effectiveness. Central to this stance
is increasing focus on clients, to achieve a more conscious and transparent bal-
ance between the social and commercial goals in all aspects of strategy and man-
agement (see also the chapter by Frances Sinha on the seal of excellence in
microfinance).
I focus primarily on so-called credit-led microfinance, an approach that cre-
ates large, financially sustainable institutions that build a physical infrastructure
to deliver financial services, and fund these services primarily through interest
charged on loans (as well as fees and other charges). I also consider alternative
approaches to microfinance, and examine the extent to which the challenges
are common.
The second section of the chapter focuses on solutions and presents a man-
ifesto for client-focused microfinance. This section focuses on four areas:

• Deepening financial inclusion: overcoming exclusion of poor, vulnerable,
and marginalized groups.
• Creating value for clients: starting with clients and their needs, and build-
ing sustainable institutions that deliver value.
• Protecting clients from harm: recognizing client risk and vulnerability in
regulation, governance, and systems to protect clients.
• Ensuring quality of microfinance services: developing effective manage-
ment systems to deliver on these objectives.

Challenges to the Field and Solutions 55

STATE OF PRACTICE—
CHALLENGES TO MICROFINANCE

I think we have done great harm in excessively hyping microfinance.
The reality and [myth] are so far apart that it creates unrealistic expec-
tations for industry.
Asad Mahmood, Deutsche Bank3

Microfinance is recognized as an important development intervention. Access
to financial services can both protect and promote poor people’s livelihoods,
helping them better plan for anticipated financial needs, cope with crises and
emergencies, and invest in economic opportunities such as a microenterprise to
improve their income. Financial access in turn can lead to improved access to
basic necessities such as food, clothing, shelter, health, and education. Comple-
mentary nonfinancial services and the positive support of staff or group mem-
bers can help to facilitate these outcomes. Microfinance also provides a platform
for integrating or linking to a range of other developmental services.
Microfinance is also an industry that is coming of age, with impressive
growth in numbers of clients, exceeding 50% per annum in many countries.4
The Microcredit Summit 2011 Campaign reports an increase in credit cus-
tomers from 23.5 million to 190.1 million between 2000 and 2010, and an in-
crease from 1,567 to 3,589 microfinance institutions (MFIs) reporting to the
campaign.5 Microfinance has grown to become big business, with more than
US$4 billion now invested through 78 microfinance investment vehicles, mak-
ing up a worldwide industry valued at more than US$65 billion.6
Yet the potential market for microfinance remains vast, with some 3 billion
adults lacking access to even basic formal financial services.7 The challenge of
scale has been the driving concern over the past decade. Rapid growth demands
access to increasing amounts of capital. Commercialization—which allows
MFIs either to access capital through savings mobilization or through the cap-
ital markets—is a key aspect of this approach.
For many, the successful initial public offering (IPO) of Compartamos in
Mexico in 2007 and SKS in 2010 validate this approach, with ACCION, for ex-
ample, commenting, “The financial markets have shown the true value created
by high-performance, double bottom line–oriented microfinance institutions.”8
But the win-win vision of a business approach to solving social problems is
under attack. The IPOs in Mexico and India highlight the potential for micro-
finance to attract investment driven predominantly by profit. The success of these
IPOs (not least for the MFI directors and investors) has led to moral outrage in


some quarters, and a sense of disquiet in others. There is particular concern when
high interest rates are perceived to drive high financial returns for the investors
in microfinance, rather than efficiency gains being translated into lower costs
for clients. Although Compartamos enjoyed high levels of client satisfaction, its
interest rates were relatively high for the Mexican market (and at around 100%
APR very high internationally). These rates were justified as generating capital
for growth, but following the commercialization of the bank, interest rates were
maintained, generating returns of 100% annually, and fueling the huge interest
in the IPO. Rich Rosenberg writing for CGAP9 asks, “To what extent do the
profits come out of the pockets of poor customers? And are the profits used for
further service to more poor people, or do private investors capture them?”
Meanwhile the erosion of client livelihoods through increasing energy and
food prices, recession, and retrenchment is leading to client overindebtedness
and delinquency, and exposing weaknesses in MFI systems overstretched by
rapid growth.10 There are reports of increasing unethical practices by field staff
chasing high productivity targets. The Centre for the Study of Financial Inno-
vation (CSFI) Banana Skins report for 2011 concluded that credit risk is now
the number-one challenge for MFIs, demonstrating the challenges to the very
foundation of microcredit—the ability of clients to repay their loans.
Although commercialization allows microfinance to achieve scale, increasing
the number of clients is, by itself, an indicator neither of positive impact nor the
strength of an institution. Although some believe that providing access to financial
services is by definition a socially useful activity, experience has shown that social
outcomes of microfinance are not automatic but rather the result of prudent strat-
egy, design, management, and governance. As the recent global financial crisis
demonstrates, social performance in financial services cannot be taken for granted.
The benefits of microfinance are being questioned, too. Academic studies over
many years have reported generally positive but inconsistent impacts of micro-
finance,11 and recent studies have failed to find widespread and consistent poverty
reduction impact.12 The lack of generalizable results has been picked up by an in-
ternational media quick to highlight the shortcomings of microfinance. In part,
microfinance has been overhyped, characterized by many as the silver bullet in the
fight against poverty. Although most practitioners would recognize this as a huge
exaggeration, the claim is seldom challenged by those inside the industry and in-
deed perpetuated by glossy promotional stories of client successes. It is time is re-
focus on how to achieve and demonstrate positive outcomes for clients.

Crisis in Some Competitive Markets
There is a consensus from my conversations that in overheated markets there
are real challenges that have the potential to both harm clients and prevent


microfinance from fulfilling its potential for positive impact, as well as damag-
ing the financial performance of the sector. “We have moved beyond anec-
dotes,” says Jean-Pierre Klump from Blue Orchard, a microfinance investment
vehicle. “The microfinance industry, although still young, has reached a level of
maturity [such] that recent events can be seen as systematic and need to be taken
seriously.”13
While competition and commercialization can stimulate improvements in
client service and improved efficiency, MFIs can compete equally by simplifying
their products or pushing credit, insurance, and other products to increase prof-
its. In some cases, concentrated competition has clearly led to negative conse-
quences, particularly in India where there is the added pressure of investor
expectations and the lack of balance created by regulatory prohibitions on deposit
taking. Many people highlight the particular danger of the combination of rapid
growth and competition, combined with weak regulation. Citing the examples of
countries such as Nicaragua, Bosnia, Morocco, and Pakistan, a CGAP report
concludes, “Microfinance grew remarkably rapidly but the repayment problems
now evident in these four countries suggest that growth came at a cost.”14
In rapidly growing organizations, developing and retaining the necessary
staff capacity to effectively deliver quality services is a challenge. High rates of
growth put huge pressures on management systems, challenging the ability to
ensure consistency in service delivery. This has been the experience of many
MFIs—in both competitive and less competitive markets. Reille highlights the
loss of quality and efficiency of staff, the focus and effectiveness of middle man-
agement, and the inadequacy of internal controls: “The drive towards scale also
brings with it a preoccupation with rapid expansion that can easily erode good
banking principles, to the detriment of the institution (in the form of deterio-
rating portfolio quality) and of clients (in the form of over-indebtedness).”15
For the first time, most of the money in microfinance comes from private
investors. There is a sense that the growth of commercial investors leads to a
change of focus with more emphasis on short-term returns and a concern that
investors will push MFIs to maintain relatively high interest rates in order to
generate high rates of return. Importantly, publicly listed companies have a legal
obligation to maximize return for their shareholders. Chen et al. highlight the
concern that “excessive commercialisation will tilt the gains heavily toward in-
vestors at the expense of the poor.”16 Maya Prabhu, head of philanthropy at
Coutts, a private UK bank, advises wealthy clients on investments in micro-
finance. She concurs and feels that “there is definitely a risk of new sharehold-
ers switching MFIs’ missions from alleviating poverty to chasing volumes and
profits.”17
One particular example highlighted by the experience in India is the move
to generate loan capital through the capital markets rather than through deposit


taking. This is seen by many to encourage people who may not understand
some of the fundamentals of microfinance to prioritize short-term financial re-
turns: “There is a lot of greed coming into microfinance. A lot of people wish
to make a lot of money out of it, and that worries me.”18

Challenges of a Focus on Growth and Efficiency
Quality must come first. We try to grow as fast as we can in a way that
we protect the quality of what we do and products that we give to the
clients.
Carlos Danel, Compartamos19

In most regions of the world, competitive microfinance markets are a long way
off, yet growth in client numbers, portfolio size, and efficiency remain the dom-
inant benchmarks of success. There is a strong sense from my conversations
that the highly competitive markets are extreme examples of issues that apply
more generally to credit-focused microfinance that pursues institutional growth
and sustainability without an equal focus on client growth and sustainability.
“In a heated marketplace all of the systemic issues that were present rise to the
fore and get out of control,” states Frank DeGiovanni.20 These challenges are
present from day one.
Decisions made in the name of growth and efficiency often directly under-
mine some of the core aspects of an MFI’s methodology and systems key to en-
suring outreach, value, and protection for target clients. Often changes are made
without a full understanding of what they imply for social as well as financial
performance. There are challenges in a number of areas.

Mission Drift
Mission drift is not an exclusive risk of commercial MFIs. It’s a risk in
all MFIs.
Kimanthi Matua, K-Rep21

A focus on growth and efficiency leads MFIs to focus on clients who are easy
to reach and who have a secure existing income with which to repay a loan.
Poorer, more vulnerable people with insecure incomes or living in remote areas
are not an obvious choice of client. Evidence from a study by Women’s World
Banking (WWB)22 and others suggests that organizations that strongly focus on
growth in client numbers, portfolio, and efficiency are likely to move away from
hard-to-reach areas, and from women and poorer clients to more profitable
and easier-to-reach clients. Matua states, “Many of us have witnessed mission


drift happen from pressure from donors, regulators, managers, staff, and even
clients themselves.”23 This is particularly the case where an MFI transforms into
a for-profit institution where greater pressure may exist to generate financial
returns for investors. Transformation also leads to an expansion of the MFI’s
client base to include savers outside the traditional target group. Matua also
reports, “When you transform you begin to attract depositors from all segments
of market, as that is the only way you can grow. But depositors demand things
because they give you something, they demand certain services, so they influence
policy. They influence you to move somewhere away from your original micro-
finance customers. It is a continuous process to make sure you balance this cre-
ative tension.”

MFI Systems
A combination of fast growth and efficiency has the potential to undermine
MFI systems and internal control. Growth puts a strain on management systems
as relatively inexperienced people are promoted and new staff are trained
quickly. Efficiency has often been achieved through simplifying processes such
as internal control, loan appraisal, hiring practices, and increasing staff pro-
ductivity. MicroSave, for example, outlined concerns about the ability of In-
dian MFIs to manage their exponential growth: “There was a marked absence
of control systems over the maintenance of cash and cheques; many branches
where the entire staff had less than one year of experience and branch man-
agers being transferred and replaced in less than a month; lack of properly doc-
umented policies in HR, Operations and Accounts . . . the list goes on.”24

Relationships
Excessive growth and competition result in organizational systems being
stretched or streamlined in order to reduce costs, leading to reduced staff-client
time and a deterioration in relationships. In India, for example, staff produc-
tivity has been increased to very high levels, with caseloads increasing from
fewer than 400 clients per loan officer in 2007 to more than 500, and in one
case over 900,25 a point at which staff members can have very little knowledge
of their clients.
Pressure on field staff to grow their portfolios and ensure high repayment
rates, despite problems experienced by clients, often leads to short-cuts being
taken (as in assessments of capacity to repay) and sometimes harsh collection
practices (discussed later in the chapter). In group lending situations, it puts full
reliance on repayment assessments on the groups. Malcolm Harper highlights
the importance of this reduction of time with clients: “What matters is good


personal service. MFI staff with the ability and time to think, to take a view on
whether the household can afford the repayments, on their other debts and so
on. . . . I think it’s called ‘relationship banking.’”26

Client Value
Where efficiency leads to simplified processes and a small number of standard-
ized products and services, the MFI likely becomes less effective at meeting the
needs of clients. Linked to this is the WWB’s finding that MFIs often make cuts
to program aspects important for deepening outreach and creating value for
clients. Activities such as cash-flow-based credit analysis, client training, busi-
ness development services, and client assessment are often the first to go. Julie
Slama of the WWB explains, “These are the very programs that would allow
MFIs to profitably serve poor women, and without which, women will either
choose not to take loans or will fail as borrowers.”27 Often cuts may have a
greater impact on the needs of women who may benefit most from nonfinan-
cial services or have smaller businesses.
Interestingly, even some of the most commercially focused organizations,
such as Compartamos, recognize that a push for short-term growth is a risky
strategy, and that microfinance needs to be focused on long-term value for clients:
through delivering products and services responsive to client needs and ensuring
quality in the delivery of these services. Vikram Akula of SKS similarly believes
there is no intrinsic tension between profit and impact: “[Good business] is not
about extracting from the poor, but doing what is right for customers.”28

Overindebtedness
A key experience in competitive markets has been the phenomenon of increas-
ing clients’ access to credit through more relaxed lending policies and multiple
lending. Beth Rhyne describes how, prior to the crisis in microfinance in Bo-
livia in the 1990s, “Suddenly, women who had had limited access to credit were
spoilt for choice; many borrowed from multiple lenders.”29 Similarly, prior to
the collapse of Banex in Nicaragua in 2010, MFIs competed by increasing loan
sizes. According to Barbara Magnoni of EA Consultants, “Microentrepreneurs
were being offered Mother’s Day loans, Christmas loans, loans for the begin-
ning of school, housing loans, home improvement loans, educational loans, mo-
torcycle loans and more.”30
Even where some MFIs are strict about their lending criteria, this does not
stop other institutions lending to the same clients. Multiple lending is seen to be
a significant issue in competitive markets. For example, in Andhra Pradesh,
India, there are loans outstanding to more than 20 million microfinance clients,


while the number of households is about 16 million, demonstrating a high level
of multiple borrowing.31 Many people are careful not to overindebt themselves
and may have genuine need for multiple loans, but experience clearly demon-
strates that easy access to credit, particularly at times of financial stress or in the
context of pressure for consumption, can lead to clients making bad decisions.
The CSFI Banana Skins report for 2011 identifies overindebtedness as the major
cause for credit risk: “The problem is so severe that it could lead to a possible
implosion of some of the key players. . . . Increased delinquencies, program de-
terioration, damage to clients’ well-being . . . we’re seeing this issue crop up in
too many markets.”32

Toward Improved “Relationship Banking”
These challenges get to the very heart of microfinance as a business approach
to solving social problems. There is a sense that a refocus is needed on under-
standing and responding to clients, and improving the quality, management,
governance, and regulation of services to create value for clients. For micro-
finance to deliver on its double bottom line, increasing scale and commercial
focus must combine with renewed attention to clients and innovation to ensure
that services are designed and delivered in the most effective as well as efficient
way. Clearer standards and transparency are also essential to ensure that clients
are empowered to make informed decisions about the services they purchase,
and that they are protected from bad practice.

DEEPENING FINANCIAL INCLUSION:
OVERCOMING EXCLUSION OF POOR,
VULNERABLE, AND MARGINALIZED PEOPLE

I thought I was too poor to join, but now I’m very proud to be part of
my Credit Association.33

One of the most appealing aspects of microfinance is its potential to extend fi-
nancial services to the 2.7 billion people without access to them. But there is un-
evenness of outreach, a trend of moving upmarket, and a number of groups of
potential clients that tend to be excluded.
Women. Although microfinance has traditionally targeted women, recent
data from a study by Women’s World Banking shows that this trend is chang-
ing. The study shows a clear trend toward a declining focus on women clients
once an MFI becomes a regulated, for-profit financial institution. In a sample
of 27 MFIs that had made the transition from NGOs, the percentage of women


clients served fell from an average of 88.5% in the year prior to the transition
to 68.5% within four years of that transformation.34 Women generally own
businesses that are smaller in size than those of men; they have smaller cash
flows and hence a lower capacity to absorb higher debt amounts than that of
men, and women are therefore seen as less desirable clients. MFIs also may
move away from women clients due to the need for higher profitability result-
ing from increased average loan sizes.
Remote and rural areas. MFIs that deliver financial services directly need to
build up a large and costly infrastructure, which puts pressure on the organi-
zation to grow to scale and to drive down costs of delivery. The tension be-
tween the cost of the MFI’s infrastructure and the capacity of clients to reliably
pay for services lies at the heart of the challenge of outreach. It also pushes MFIs
to focus on provision of credit that can generate an income, rather than savings,
which requires a larger infrastructure to mediate very small transactions from
large numbers of people. It is therefore unsurprising that MFIs find it hard to
reach remote areas, and tend to focus on clients with a good existing capacity
to absorb credit.
Community-based models provide a lower-cost alternative to building up
the institutional infrastructure of credit-led microfinance, allowing for access
to more remote and rural areas. Groups are facilitated to mobilize and on-lend
their own savings. The groups are trained and then can become sustainable, re-
quiring minimal ongoing external support. Groups can often replicate without
external involvement. A significant subsidy is needed to facilitate the capacity
building of these groups, but proponents of this approach argue that this sub-
sidy is far less than the millions of dollars that go into building a sustainable
MFI, and that this is a lower risk approach where ultimately all the benefits
come back to the clients. Jeffrey Ashe of Oxfam-America argues that “savings-
led microfinance could provide access for much less than credit-led. The model
offers great potential to have millions of member-owned, member-managed and
member-used organizations of the poor.”35
Poor, vulnerable, and marginalized people. Most microfinance—including
community-based models—tends to exclude a significant number of the poorer
and more vulnerable population. Although the Microcredit Summit has cam-
paigned since 1997 to increase the poverty focus of microfinance, broadly in
most countries and most types of microfinance organizations, clients are pre-
dominantly those people just below and just above the poverty line. Services
rarely extend to the very poor.
For microcredit to be appropriate, the clients must have the capacity to
repay the loan under the terms by which it is provided. Where there is little to
no access to markets and very little cash in the community to support local busi-
nesses, there may be little value in credit, or it may be seasonal. Vulnerable


clients may also fear the risk of credit or just not having the confidence to join:
“It is very likely that we would spend the loan (to pay for food) and that we
would be incapable of repaying it properly. So, that could create problems that
we would rather avoid.”36 In other cases, even very poor people have been
shown to value and productively use credit. There is also broad acceptance that
access to savings is a critical need for even the poorest people. Decisions need
to be made on the basis of understanding rather than assuming that certain ser-
vices are suitable or unsuitable.

Factors Toward Exclusion
Most MFIs serve a relatively small proportion of their total potential market,
deliberately or inadvertently excluding certain groups. A number of factors lead
to the exclusion of the groups mentioned previously.
Enterprise credit. Numerous MFIs only lend to people who have an exist-
ing microenterprise rather than supporting start-ups, which are riskier and often
require training and support in addition to credit. These organizations effec-
tively exclude the vast majority of people who lack access to financial services.
MFIs’ policies and procedures. Many MFIs set eligibility criteria that serve
to exclude more vulnerable and poorer clients—for example, registration fees,
minimum loan sizes, or minimum savings balances. Gender biases are often
present, such as discrimination against women that occurs when clients are re-
quired to show title deeds for their land or house. In addition to these policies,
MFIs often inadvertently exclude people through inappropriate products and
services, or make changes in pursuit of efficiency that may have the side effect
of removing aspects of the methodology that favor weaker clients—for exam-
ple, removing client training or home visits.
In addition, staff actions and decisions respond to organizational culture,
personal biases, or incentives, and have considerable influence over whom the
organization serves. Many MFIs have a culture that rewards growth in client
numbers and portfolio size. The organization thus tends to focus on more
easy-to-reach areas and clients. Management responds by selecting opera-
tional areas in urban and peri-urban locations, or in the market center close
to the main road in rural areas. Field staff respond by targeting easy-to-reach
people, and those who are able to take a relatively large loan and grow it over
time (see Box 2.1).
There are norms in society that lead to the poorest people and other groups,
such as the disabled, being regarded as inadequate and incapable of achieving.
These norms are reflected in self-perceptions as well as perceptions among the
wider community, MFI field staff and management, and the microfinance indus-
try. Poorer people are commonly viewed as potentially problematic by field staff


Box 2.1 Staff Response to Exclusion in Malawia
During a workshop at Microloan Foundation, Malawi, staff made a com-
mitment to try to deepen their outreach by addressing exclusion factors such
as the bias of serving clients close to the branch office. Subsequently, a manager
returned to her branch and approved two groups that she had been intending
to reject because of their location in a more remote rural area.
Note: a. Personal correspondence.

and avoided. In Latin America, for example, the term “poor” implies laziness,
drunkenness, and lack of judgment. Without addressing these issues explicitly,
MFIs tend to reflect these patterns that lead to marginalization.
Exclusion by group members. Microfinance groups are normally self-
selecting in terms of membership and play a role in setting loan size. A common
experience in groups—of all methodologies—is that they are dominated by
stronger members, who may exclude weaker individuals from joining or limit
their ability to participate. This is particularly the case in groups for which ac-
cess to credit is dependent on the level of saving in the group, or in solidarity
lending where clients must guarantee each other’s loans.
Exclusion through external factors. Regulation may also serve to exclude
and can be a driver of mission drift by inadvertently making it more costly or
complex for an MFI to serve its target clients. Examples include requiring all
clients of MFIs to have national identification cards; classifying all loans to in-
formal business as consumer rather than enterprise loans, thus requiring higher
provisioning for portfolio at risk; or a requirement to make credit bureau checks
before lending, where this may cost 10% to 15% of the loan, and prove im-
practical when trying to get groups in remote rural areas to make decisions
about their loans.

Overcoming Exclusion
Organizations that seek to reach certain groups do so. It’s a question
of will.
Anonymous survey respondent37

If a goal of microfinance is financial inclusion, then the challenge is to reach
out to those people who could benefit from financial services who are currently
excluded. Where an MFI defines particular target clients, products and services


should be designed to meet their needs, and that outreach is monitored and
managed. In addition, many MFIs have the potential to deepen their outreach
by understanding factors that lead to exclusion of potential clients, and making
adjustments in response.
While poorer, vulnerable, and more remote clients may be more costly or
risky to serve, considerable evidence exists that these trade-offs are not auto-
matic.38 When MFIs put effort into designing their programs to serve these
groups, the difference can be dramatic, and can be accomplished sustainably.
For example, often with targeted communication and an appropriate organi-
zational culture, services can be made more conducive to these potential client
groups. A focus on savings rather than credit—at least initially—may often be
more appropriate. Guy Vanmeenen describes the approach of Catholic Relief
Services (CRS) in working with savings and credit groups. CRS began by form-
ing a group with those who are less risk adverse and not the poorest. After
about eight to 10 months, once the group has shared out their savings, a demon-
stration effect takes place and others see the benefits. Effort is then needed to
form subsequent groups within the same community, and to include groups with
a lower minimum savings balance to ensure the inclusion of the poorer people.
More savings groups continue to be formed until the market is saturated.39 The
following two examples illustrate approaches to deepening financial inclusion.

AMK, Cambodia
AMK demonstrates the practical steps an MFI can take to overcome exclusion
and deepen financial inclusion. AMK has been ranked number 17 in the world’s
top 100 MFIs, serving 250,930 clients with 108% operational self-sufficiency
as of December 2010. It is also notable for its focus on serving poor women in
rural areas, with around 90% of its clients rural, 86% female, and 56% below
the national poverty line. Plus AMK has Cambodia’s lowest average loan out-
standing at US$115, compared to a national average of US$411. It has deepened
its outreach through a series of steps.
Segmenting its client market and adapting services to their specific needs.
AMK does not directly target women or the poor; instead it attracts its chosen
target group through maintaining relatively low loan ceilings on products, and
selecting rural operational areas with higher than average poverty rates. AMK
has also adapted its savings and loans products to the specific needs of rural
agricultural households, with flexibility of loan terms and timing, and the op-
tion of installment or end-of-term loans.
Creating appropriate organizational culture and staff incentives. AMK has
been particularly successful in building and maintaining a social performance
culture in a context of rapid growth, and retaining this as personnel, manage-
ment, and board members change. Regular reports on social performance serve


to keep attention focused on the social aspects of the mission, and have led to
integrating related reporting into other departments—for example:

• Making social performance a core element of formal staff training.
• Incorporating a social dimension into staff appraisal through HR and an in-
ternal audit.
• Including in staff incentives a difficulty rating that takes into account more
challenging rural environments.

Small Enterprise Foundation (SEF), South Africa
In the case of SEF in South Africa, some relatively simple steps—including start-
up businesses and poverty targeting—successfully transformed a program that
was serving predominantly women above the poverty line, MCP (formerly
Microcredit Programme), into one that serves predominantly very poor women,
TCP (formerly Tshomisano Credit Programme). Figure 2.1, illustrating results
from the CGAP poverty assessment of SEF, shows a huge difference in poverty
outreach.40 While MCP predominantly reaches clients from the least poor group
and has few clients from among the poorest third, TCP is biased toward poorer
people. What is more, despite smaller initial loans and the costs associated with
poverty targeting, lower arrears and higher client retention in TCP mean that,
in the long term, the programs are roughly comparable in terms of their finan-
cial performance.

Figure 2.1 Comparing Poverty-Targeted (TCP) and Non-Targeted (MCP)
Microfinance Programs of the Small Enterprise Foundation, South Africa

60%

50%

40%

Non client
30%
TCP client
20%
MCP client

10%

0%
Poorest Less Poor Least Poor


CREATING VALUE FOR CLIENTS

I guess fundamentally financial services are about clients, they are about
people, because at root they are about helping people manage their
lives. The financial services are designed to help the clients build assets
and help clients move towards financial security or economic security.
Frank DeGiovanni, Ford Foundation41

As a social business, microfinance has at its core an intention to create benefit
or value for its clients. This section examines in more detail how this intent can
be put into practice.

Adapting Financial Services to Clients’ Needs
In recent years there has been a move away from seeing microfinance as credit
for self-employment to recognizing the wide-ranging use and value of financial
services—savings, credit, insurance, and remittances. Access to relatively large
sums of money compared to a client’s regular income gives that person the
means to better manage her or his finances, which can help in planning for and
meeting expected household needs such as paying for school fees or buying rice
or maize in bulk. It also helps increase resilience and reduce vulnerability to the
many risks that poor people face. In addition, financial services can help poor
people take advantage of economic opportunities or invest in productive as-
sets—for example, starting or growing a micro enterprise—and generate in-
creased income that in turn increases access to basic necessities such as food,
education, health, and shelter, and a general improvement in living standards.
The availability of financial services in a market, though, does not neces-
sarily mean that the services are well suited to the needs of clients or even that
they are used. Provision of microfinance in agricultural communities is a good
example of where the traditional product of weekly repayments does not meet
the needs of a rural producer for a big lump-sum loan at the beginning of
the agricultural production cycle and repayment only after harvest time. As
deGiovanni of the Ford Foundation states, “So if you were measuring it from
a financial inclusion paradigm you would say, well, the services are there. From
our point of view that product is not meeting the needs of that population. The
product needs to be retooled so that it’s adapted to the economic needs of a
rural producer.”42
A client focus reveals opportunities for improvements for most (if not all)
organizations. Often small adjustments can have a big impact. At a recent micro-
finance innovation conference,43 several studies suggested that small tweaks to


the products offered by MFIs—such as allowing a grace period before repay-
ment of a loan, offering loans in-kind rather than in cash, or providing very basic
financial training—can dramatically improve outcomes for borrowers. Other
changes to the delivering of financial services might include fitting in with the
seasonality of client livelihoods, making services more accessible through mo-
bile services, or building support between clients with the use of groups (see Box
2.2): “Up to now, no one has progressed because of the repayment schedule of
one week. At least with one month (as a deadline) I could have gone all the way
to Bamako to buy merchandise and made a profit. It becomes harder during the
rainy season” (MFI client).44
While understanding of clients’ needs for diverse and flexible financial ser-
vices has greatly improved, why is the industry still relatively undifferentiated,
with the majority of MFIs providing a very limited range of services? One of the
strongest messages I hear repeatedly is the weakness of many MFIs in under-
standing and responding to the needs of their clients (and potential clients). As
Chris Dunford from Freedom From Hunger states, “A famous business adage
is ‘know your customers’: the irony is that many MFIs, which try so hard to be

Box 2.2 AMK Adaptations to Fit Rural Livelihoods
AMK caters primarily to rural agricultural households, a market that is
characterized by poor infrastructure and regular floods and droughts.An un-
derstanding of client vulnerability and seasonality is therefore central to the
design of products and services.AMK identified that many clients have nonfarm
incomes, and that clients’ financial needs change throughout their lives as their
lifestyles and income sources change.To address these needs AMK provides:
Group loan products with complete flexibility of repayment: De-
pending on their income stream, clients can choose between installment or
end-of-term loans.
Individual loan product that caters more to nonfarm opportunities:
Individual loan products are also available for stronger clients. These include
regular, business expansion, and seasonal loan products.
Disaster mitigation products: These are emergency loans without col-
lateral, which provides a flexible end-of-term repayment option. A microinsur-
ance product is also under development.
A range of savings products: These allow for readily accessible deposits
and withdrawals or fixed deposits for clients who want to save their money for
a specific purpose.
Source: Adapted from Managing Social Performance:AMK (Cambodia),Imp-Act Consortium,and www.akm
cambodia.com.


businesses, aren’t following this adage and often neglect the needs and interests
of their clients.”45
In part, running an MFI is tough, and the margins are small. Much of the
early development of microfinance centered on replication of successful mod-
els rather than seeking to understand client needs in each context. Lending tiny
amounts of money is costly, so standardization of products and processes was
viewed as the only way to get the products to the population at a reasonable
cost. Jeffrey Ashe of Oxfam America describes his experience in Bolivia in the
1980s: “We assumed—a strange assumption—that the poor needed to save by
taking on debt. The mantra for us as institutions was to keep it simple, offer one
product, drive down cost, and expand the market. That had its own internal
logic, but it didn’t meet the needs of clients.”46
From the late 1990s there was an increasing awareness of the need for a
more client-led approach, and increasing focus on adaptation and diversifica-
tion of products and services to fit a much more segmented client market. Al-
though there are many examples of organizations that have a strong focus on
understanding their clients and which continually seek new ways to create ad-
ditional value, these organizations are a minority. Many MFIs, for example,
continue to provide credit that is poorly adapted to the business needs of its
clients (see Box 2.3). One of the key messages of this chapter is the need for a
much greater application of what we know about how microfinance services
can be tailored to the needs of different client segments.

Key Areas for Development
of Responsive Financial Services
Improving credit products: Moving beyond credit for enterprise. Although
microfinance has diversified significantly, many MFIs still implement a rigid
credit-for-enterprise approach that fails to adequately take into consideration

Box 2.3 Examples of Poorly Adapted Credit
• All members of a group take loans at the same time and for the same du-
ration, meaning that loans are not available at the time when they are
needed and may not fit with the business cycle of the clients’ enterprise.
• Repayments must commence a week or two after disbursement, mean-
ing that clients have not had a chance to invest the loan and generate a
profit; clients often hold back part of the loan disbursed to make their
early repayments.


the complexity and needs of poor people’s financial portfolios, and does not
allow flexibility where it is needed.
While providing credit for investment in a business is an important mech-
anism for raising the income and productive assets of clients, other unaddressed
financial needs will lead to “misuse” of the loan—for example, paying school
fees or coping with illness. In addition to enterprise investment, credit has an im-
portant role to play in enabling improved financial management and respond-
ing to crises—particularly where insufficient savings have been mobilized.
The response of many that money is fungible and that loans should not be
tied to any purpose—the client knows best—is equally problematic, risking los-
ing the opportunity to support clients in building a viable business and, if not
carefully managed, creating a risk of overindebtedness.
Designing loan products. A central message is that the way in which loan
products are designed is as important (if not more so) than the products avail-
able. For example, Freedom From Hunger has been working on a more flexi-
ble group lending product that allows clients to save in the group when they do
not need to borrow and to borrow for the term, amount, and repayment sched-
ule that makes sense for them. Not everyone in the group needs to borrow and
pay back on the same schedule. Approximately 30% of group members at any
one time do not have a loan, but continue to save. These features are very much
appreciated by the clients, but, of course, it comes at the cost of increasing com-
plexity of transactions and thus transaction costs for the MFI. The success of
this approach is also reliant on strong group processes and ensuring that clients
are really empowered in decision-making processes. This again requires invest-
ment of time by the MFI.
Perhaps the most notable change in methodology toward greater respon-
siveness to client needs is the experience of the Grameen Bank in its move to
Grameen II methodology. Box 2.4 outlines how the organization has reengi-
neered itself to better take account of the realities of the lives of its clients and
their needs, with a much greater degree of flexibility and greatly improved sav-
ings services.
Improving access to savings and other financial services. Much of the em-
phasis in microfinance has been on credit. Yet credit is debt and creates addi-
tional risk for the clients and increases their vulnerability. We need to be realistic
about recognizing that microfinance cannot create benefits all the time, and
with credit in particular negative outcomes are inevitable some of the time.
Credit can provide additional capital for larger demands, allowing expenditure
to be brought forward or to make a productive investment, and therefore may
be worth the risk. Credit may also be important in responding to a need where
it would take too long to save sufficiently, or where cash is urgently needed.
However, in many cases where the real need is for expenditure smoothing or to


Box 2.4 From Grameen I to Grameen II
“The way I look at Grameen II, even more so than when it was launched, is
it’s trying to make it kind of client-friendly, or as Dr. Yunus said at the time,
‘take the tension out of microfinance’ and yet have a clear accountability, so
that you can bear with the fact that sometimes things don’t go as planned.”
—Alex Counts, Grameen Foundationa

Grameen I
This system of delivering credit was one that involved poor women taking loans
from Grameen and undertaking the responsibility of other group members in
case of a default or delay. All group members took their loans at the same time,
and repaid over a period of 52 weeks with a fixed weekly sum for repayment.
However, the 1998 floods in Bangladesh made amply clear the “internal weak-
nesses in the system,” as Yunus says.The main weakness was the rigidity in the
lending scheme.The repayment for a fixed schedule was the same for everyone
and could not be altered: “Once a borrower fell from the track, she found it dif-
ficult to move back on,” and this meant that opportunity for future loans was
endangered. Repayments began to decline sharply in 1998, and Grameen II was
in response to this, with its main “weapon” being greater flexibility.

Grameen II
In 2000 Grameen Bank initiated a major revamp of products and services with
the understanding that customers’ credit needs have been evolving and that
credit alone is not sufficient to meet the needs of the poor. Among the most
important changes were those made to the products:
• Mobilizing savings from the general public and not only Grameen customers.
• Increased flexibility in savings products—no group savings products, flex-
ible personal savings, commitment-based pension product, and so on.
• Loan contracts were flexible with a wider range of products, variable
terms, and repayment schedules. [Also included were] larger loans for
business, a top-up loan facility, and introduction of rescheduling of loans
in case clients are in difficulty.
While the Centre Managers work closely with the clients and determine the
products that they should have, as product knowledge is spreading Grameen
members are increasingly gaining control of this aspect.The role of the manager
is evolving from being a “teacher” to an “officer who supplies information and
financial advice to clients who themselves determine the products and services
they require.”
Source: Adapted from MicroSave Briefing Notes #1 and #8 on Grameen II


cope with an unanticipated problem, other financial services may be more ap-
propriate or complementary to credit.
Savings are a low-risk way to better manage the resources that you have.
While the appropriate balance between credit and other financial services may
be debated, clearly savings have an important role in meeting day-to-day fi-
nancial needs and for coping with emergencies. Yet most institutional micro-
finance focuses primarily on credit, with savings mostly confined to compulsory
savings that act as a substitute for collateral rather than serving a useful func-
tion for clients. While the need for savings is understood, a tension exists be-
tween our understanding of client needs and the services MFIs are able to offer.
Savings are more tightly regulated and less profitable for MFIs, so significant
challenges arise when providing access to this service (see Box 2.5).
In addition to savings and credit, other financial services such as insurance
and remittances are also important tools for poor people’s financial manage-
ment. Insurance when well structured can help clients cope with emergencies
without damaging their livelihoods, and remittances are a crucial lifeline for
millions of the world’s poor. Again, access to these services alone is insufficient,
and attention needs to turn to their design and delivery to create value. Women’s
World Banking, for example, highlights how microinsurance can be designed
with the specific needs of poor women in mind. Poor women have traditionally

Box 2.5 The Experience of Cashpor, India in
Mobilizing Savings
In India, MFIs are not allowed to raise public deposits, so in order for en-
tities like Cashpor to facilitate saving services they have to be listed as a “busi-
ness correspondent” of a bank, whereby the MFI acts as the bank’s agent,
representing the bank’s products and services to the customers in exchange for
a small fee.
Cashpor is strongly of the view (corroborated by the market research that
Grameen Foundation has undertaken) that there will be a good demand for
“commitment” saving products with doorstep service, given customer prefer-
ences and their income flow patterns. As of now, Cashpor has not started of-
fering the saving service but is in discussion with various banks. However, as a
banking correspondent, Cashpor does not have the freedom to independently
develop its products, except that it can influence decisions of the bank.
Source: Santosh Daniel, Grameen Foundation (working with Cashpor to support development of sav-
ings products)a


managed risk in very risky ways: by relying on their husbands, pulling children
out of school to work, or selling productive assets such as livestock or equip-
ment. Gender-sensitive microinsurance might cover ill heath due to maternity
or childbirth, or give women the choice of selecting another beneficiary if they
do not think their husbands will protect the children properly after the woman’s
death. In Colombia, one company’s life insurance pays monthly benefits that
can be used for the purpose of educating the children for two years after the
death of a parent, in order to reduce the pressure on the surviving parent to
pull children out of school.47
Community-based savings and loans. In most communities, informal savings
and credit groups exist that serve as an important tool for financial manage-
ment. Groups focus on building up relatively small amounts of savings that can
be lent out to the group, and help people manage anticipated and emergency
needs for money. A number of organizations have developed community-based
models of microfinance that build on traditional savings and credit groups. The
groups, when they are properly trained, build in flexibility; the loans are small
enough for the clients not to get into trouble, and all the profits return to the
members as each member builds his or her own savings account.
While savings groups are generally supportive and loan terms are flexible,
savings are locked in for a predetermined cycle, rather than accessible when
needed. Interest is paid back to members (rather than covering the costs of an
MFI), but stronger members often become net savers (and, on balance, benefit)
and weaker members become net borrowers (and, on balance, pay interest). In
addition, as the money is shared out among the group annually, the groups do
not build up money over time, and thus are not terribly good at building up
sufficient capital for investment in enterprises or longer-term needs for life cycle
events such as weddings or funerals. Lauren Hendricks of CARE reports, “In
my experience, mature VSLA groups frequently start to request additional, more
formal financial services in order to meet some of the shortcomings of savings-
led groups.”48 This creates an opportunity to build linkages between these
groups and other financial institutions. For example, in India the self-help group
linkage program provides capital from banks to self-help groups that meet cri-
teria demonstrating the viability of their financial systems.
The strengths of community-based microfinance in mobilizing savings and
providing an institutional model that does not push credit clearly represent one
aspect of the solution to the challenges in microfinance. Somehow, we have to
capitalize on the good of encouraging savings and self-management while in-
creasing flexible access to these savings. Thus, it would seem that both the credit
and savings-led approaches have strengths and weaknesses when analyzed from
a client perspective, and lessons result from both models.


Some models seem to fuse the strengths of each approach. The original
methodology for Village Banking, for example, used extensively in Latin America,
included the establishment of an internal savings fund that could be used to
meet anticipated and unanticipated needs through loans to group members.
This approach complemented the larger working capital loans that the micro-
finance organization provided. While this plan seems to provide an ideal com-
bination of financial services, the internal fund was gradually withdrawn by
most MFIs as it was seen to be costly to facilitate and competed with the MFI’s
external loans and therefore undermined the MFI’s financial sustainability. Some
MFIs such as Finca Peru have retained this internal fund (see Box 2.6).
Guy Vanmeenen of CRS cautions, however, against overoptimism in these
linkages, and highlights the value of giving people access to a range of different

Box 2.6 TheValue of the Internal Savings Fund (Finca Peru)
Finca Peru includes compulsory savings, which act as security for the MFI.
There is also an internal group savings account.As of February 28, 2011, Finca’s
loan portfolio was US$3,920,804, while member savings were US$4,064,987.
From the savings around 70% is lent as internal account loans. Iris Lanao Flores,
executive director, describes the internal account as a complement to the Finca
business loans. Internal fund loans are flexible, with members choosing the num-
ber and regularity of installments, and can be used for any purpose, allowing
members to better overcome emergencies, improve housing conditions, and ed-
ucate their children. Interest rates for internal and Finca loans are the same, al-
though at the end of their loan cycle internal interest is paid as dividends relative
to the amount of savings each member has.
There are financial pressures on Finca Peru in maintaining the internal fund,
however. The institution’s staff track the groups’ internal savings and loans, a
costly undertaking for around 16,000 clients. Field staff manage their own port-
folios as well as supporting the solidarity groups to manage their internal funds,
and as Flores says, having both Finca Peru loans and group loans available means
“we don’t need outside competition, we have it within.”
Flores does not see this as a disadvantage—quite the opposite:“The costs
are very high but . . . we have been self-sufficient both operationally and finan-
cially since 1998. ROE is more than 10% so we can invest on expansion in the
most remote rural areas in the poorest areas of the country. During our life-
time, we have stubbornly maintained our methodology for empowerment, using
microfinance as a tool.”
Source: Iris Lanao Flores, executive director, Finca Peru


services, rather than trying to provide for all needs in one model: “Financial in-
clusion is about having as many different types of products and services as pos-
sible to everyone in rural areas, to the poor. One of the dangers is that . . . people
say, can we do more, can we add on more, can we make it more than it is? We
have to be humble and be clear on what the limitations of this are. You don’t
necessarily have to address the limitations.”49

Adding Value Through Nonfinancial Services
The basic spirit of microfinance is to search for possibilities based on
knowledge, understanding, and perspectives that start at the ground
level. We understand our clients and their needs. There is no reason
why we cannot use those same skills to address the other constraints
our clients face.
Fazle Abed, BRAC50

There is much debate about whether MFIs should or should not provide non-
financial services. Some MFIs recognize the true potential of microfinance as only
being realized when the opportunities to link or integrate a wider range of services
are taken. BRAC, one of the world’s largest NGOs, typifies this logic: “In BRAC
we saw that many women were stuck in low-return activities. We saw that many
were involved in poultry but were not making much money because of diseases.
So we trained a person in each village organization to do vaccinations, treat basic
diseases, and train in proper feeding and hygiene. These people get paid for the
services they provide to the women who raise chickens” (Fazel Abed, BRAC).51
Others argue that MFIs should focus on the things they do best—deliver-
ing financial services—and concentrate on improving them. Carlos Danel ex-
plains the approach of Compartamos: “As an institution, we realize that other
services are important and that microfinance is not a panacea. Other services are
needed to drastically change lives of people below the poverty line. But these we
cannot do.”52 Clearly there will always be opportunities to do more to create
social value for clients, and there must be a balance struck between undertak-
ing additional activities for social reasons and the viability of the business. Yet,
it is not a question of whether an MFI chooses to provide financial services, but
a practical question of their capacity to respond to clients’ needs. There may be
opportunities or limitations to providing both financial and nonfinancial services.
The infrastructure of microfinance with outreach to millions of people,
often with regular meetings, creates a huge potential to add value: integrating
or partnering to create access to nonfinancial services such as financial educa-
tion, business training, health education, or legal and rights-based services. By


starting with an understanding of the client and her needs it becomes clear how
nonfinancial services can complement financial services and create benefits for
clients and MFIs:

• Investment in an economic opportunity and productive assets. While an
appropriate loan might be important for a microenterprise, it may be that
business training, marketing, or access to high-value products would in-
crease the likelihood of success in terms of growth and profitability. A
supportive group might also be an important contributor.
• Managing for anticipated financial needs. A range of affordable and ac-
cessible savings and credit products may assist clients in meeting their
needs, but financial literacy training might enhance outcomes.
• Coping with emergencies. Similarly, while savings, insurance, or emer-
gency loans may help reduce client vulnerability to emergencies, other in-
puts could also reduce the likelihood of problems, such as facilitating
access to health services and establishing well-formed and facilitated
groups that are likely to support one another in times of crisis.
• Other social benefits. Other outcomes pursued by many MFIs—such as
women’s empowerment and improvements in health, housing, or educa-
tion—are all much more likely to be achieved through a combination of
financial and nonfinancial services. Groups, for example, have the po-
tential to create benefits such as increased confidence, strengthening of
social relationships (in the family and community), and empowerment.
These outcomes are mediated by the nature of specific groups, and de-
pend to a large degree on the relationship with MFI field staff. Micro-
finance can also help right power inequalities between women and men,
but not without “a clear commitment and strategic approach to ensuring
that it does.”53 These might include awareness, literacy, and related skills
development or strategies to affect men’s behavior toward women within
the household and local community.

Business Models for Combining
Financial and Nonfinancial Services
In some cases—such as the BRAC example—a social business model may be
able to sustainably deliver nonfinancial services. In others, some nonfinancial
services may be integrated into financial services. Many organizations, for ex-
ample, provide support such as business skills training, marketing, or provision of
high-value products. In Tunisia enda inter-arabe, for example, includes business


Box 2.7 Freedom From Hunger: Meeting Client Needs to
Avoid Loan Dispersion
In giving loans intended for businesses which are in fact used by clients on
a variety of other pressing needs, MFIs risk potentially overindebting their
clients.The issue, however, is not one of clients using the loans “incorrectly,” but
of MFIs not adequately meeting client needs. Freedom From Hunger has been
working with a number of MFIs to address this issue, particularly in relation to
use of loans for health needs.
Though there are a large number of reasons for clients to default or drop
out, one of the most common is ill health, either of the client or family mem-
bers. Sickness impacts those living in poverty particularly hard.A recent study
in Ghana indicated that the cost of malaria treatment represented just 1% of
wealthy families’ income but 34% of poor households’.a The natural response
one would think when faced with such pressures is for households to divert
loans intended for other uses—microenterprise, for example—to urgent health
expenses. This is corroborated by research carried out by Freedom From
Hunger at five MFIs, which revealed that large proportions of clients resort to
using business loans for health-care expenses, ranging from 11% of clients at
RCPB in Burkina Faso to 48% at Bandham in India.b
Freedom From Hunger has shown that providing clients with appropriate
“microfinance plus” health services potentially allows clients to meet their
health needs as required, enabling clients to be more successful—less likely to
default and drop out—and the MFI to benefit not only from meeting its social
mission, but from improvements to its bottom line.
In addition to “impressive net social value creation,” the research concluded
that the combined products make good business sense. Health protection prod-
ucts tested included health education, health savings, health loans, health micro
insurance, linkages to health providers, and the sale of health products in rural
communities. Some of these products are expected to break even and even
begin earning net profits in coming years, and other non-revenue-generating
products (such as education) may soon cost less due to economies of scale.
Notes: a. M. Reinsch, C. Dunford, and M. Metcalfe,“The Business Case for Adding Health Protection to
Microfinance,” Freedom From Hunger, June 2010, 3.
b. A. Kobishyn, “Opening the Black Box: How the Poor Use Credit in India,” Microfinance Insights 12
(May/June 2009).

development services as a core product: “We have information and discussion
‘circles’ (on a wide range of subjects about business and social matters). . . .
This contributes to an atmosphere of confidence among the clients and assists
them in using their loans wisely.”54


Other MFIs may decide that they do not have the capacity to diversify be-
yond financial services, and they seek partnerships or linkages with other or-
ganizations to deliver services that create synergies with their financial services.
TRIAS, a Belgium MFI, works in this way: “We start at the level of organized
farmers, and we analyze their needs with them, then we look for a partner mix
who can guarantee these services. This can be the MFI itself or another actor”
(John Blieck, TRIAS).55

Listening to Clients
What separates legitimate microfinance is our interest in continuous
improvement to meet client needs. We sometimes err, but we should al-
ways learn and improve. Being honest about our mistakes and opening
ourselves to criticism is part of the process.
Davis Broach, Relief International56

A characteristic of successful client-focused organizations is regular feedback
from and dialogue with clients (see Boxes 2.8 and 2.9). For example, enda inter-
arabe integrates discussion circles into its methodology, holding regular group
discussions on a wide range of subjects about business but also about social mat-
ters, as well as client and exit surveys: “For us, listening to clients and improving
our products, as well as introducing new products, comes naturally” (Michael
Cracknell, enda inter-arabe).57
MicroSave has been a strong advocate for client-led microfinance and pro-
vides numerous case studies of how learning from clients drives improvements
that benefit the clients and the financial performance of the organization. Ser-
vices better meet clients’ needs, and clients are less likely to take inappropriate

Box 2.8 Integrating Client Feedbacka
Over the last decade, Opportunity International has conducted more than
50,000 face-to-face surveys with clients in Africa,Asia, Eastern Europe, and Latin
America.The research showed that clients want savings as much as they want
small business loans, and their input has aided the development of a wide array
of financial tools—including agricultural finance and rural savings, crop and
health insurance, school fee loans, and savings accounts—to improve the stan-
dard of their lives while they work their way out of poverty.
Note: a. Personal correspondence from Opportunity Director


Box 2.9 Compartamos—Adapting Financial Products to
Client Needsa
When researching its life insurance product, Compartamos discovered that
when a family loses a bread earner, negative family cash flow typically takes
about 1.8 years to recover.This included not only loss of income, but also the
expense associated with the funeral.There are limited possibilities to raise funds
quickly so an immediate loan is usually sourced from a moneylender or pawn
shop, making the cost even higher. Compartamos designed a low-cost life in-
surance product, but it was difficult to sell because of people’s unwillingness to
pay for a future event. So in focus groups they asked clients what would be
more appealing: lower the interest rate on their loan or build in life insurance
(for US$1,250—an amount identified in the initial research to cushion the
shock) and overwhelmingly they chose the life insurance option, and some vol-
untarily paid an increased premium.
Note: a. Personal correspondence from Carlos Danel, Compartamos.

loans and become overindebted. The MFIs also experience increased growth,
improved client satisfaction, and fewer problems. The potential market for ser-
vices is also increased as MFIs are able to reach people in the agricultural sec-
tor, more remote areas, or simply those who do not need an enterprise loan.
When listening to clients, organizations must be careful to think about
whose voices they are hearing. Women and men often have different needs; vul-
nerable clients are less likely to participate in focus group discussions.
The point is highlighted by a client feedback survey at AMK in which 11%
of clients raised problems with “small loan sizes.” The fact that AMK’s loan size
is indeed the smallest in the local market led management to wonder whether
the loans were becoming too small to fit the needs of clients. Segmentation of
the data by the clients’ poverty level demonstrated that poorer clients were not
complaining. As a result, group loan sizes were maintained at the same level,
with individual larger loans for better-off clients (see Figure 2.2).

Balance and Flexibility
MFIs face constraints in terms of capacity, population density, infrastructure,
and regulation, all of which determine what changes are possible for each or-
ganization. A balance is important; rapid product diversification, or changes to
products, can be as dangerous to clients and the institution as rapid growth and
expansion.


Figure 2.2 AMK Client Satisfaction Data Segmented by Client Poverty Level

10%

Poorer (n = 130)

5% Medium (n = 110)

Better off (n = 49)

0%
Small loan size

Source: SPM in Practice: AMK (Cambodia), Imp-Act Consortium, 2008, www.Imp-Act.org.

A focus on building clients rather than building institutions enables an or-
ganization to identify opportunities for change. It is a journey, a process of con-
tinuous learning and improvement, and MFIs can do many relatively small
things to improve their services and create more value for their clients. As a first
step, it is about ensuring that services are accessible, timed to fit with people’s
needs, and above all do not have negative impacts.
Even where an MFI understands what clients need, there may be internal
prejudice and resistance, making change harder to achieve. When Grameen
Bank changed to a new operating system that allows clients greater flexibility
to reschedule loans, motivated by an understanding of the impact of emergen-
cies such as illness and natural disasters on clients’ ability to repay, the change
provoked strong reactions from staff convinced that this level of flexibility
would lead to the breakdown of group solidarity and widespread repayment
problems.58 This sort of resistance may help explain the relative lack of progress
in building more client-focused MFIs.
It is perhaps worthwhile to end this section with a note of caution from a
respondent to my survey for this chapter: “If MFIs started with the premise of
at least doing what they set out to do well, then perhaps they could explore
broader areas. But currently, given that the vast majority cannot even offer a
fairly priced and efficient loan to clients for productive purposes in a sustain-
able manner, perhaps this should be a priority. Learn to walk before running”
(anonymous).


PROTECTING CLIENTS FROM HARM:
RECOGNIZING CLIENT RISK AND VULNERABILITY
IN REGULATION, GOVERNANCE, AND
SYSTEMS TO PROTECT CLIENTS

This is a scary moment for the industry with its root cause being insuf-
ficient systems for tracking client indebtedness, unfettered competition,
irrational growth expectations, and little analysis and understanding of
the client’s ability to repay.
Siddhartha Chowdhury,
ACCION International country manager, India59

It is important to recognize that, as well as creating value, microfinance also has
the potential to harm its clients. This section focuses on how MFIs design their
products, services, and systems based on a recognition that illness and other
emergencies are commonplace in the lives of poor people. By protecting and
helping clients come through these problems, MFIs can significantly improve the
chances of achieving significant positive changes in the lives of their clients.

Responsible Finance
The profits that some microfinance organizations and their investors are mak-
ing, combined with the experience of client overindebtedness and coercive col-
lection practices, has led to a lot of debate about responsible finance. From a
client perspective, a number of key elements can be defined. These are reflected
in the client protection principles promoted by the SMART Campaign, an in-
dustrywide initiative supported by over 1,000 MFIs.60 In this section I highlight
the vulnerability of microfinance clients and the risks that credit in particular
creates, and focus on three key elements of responsible finance reflected in these
principles:

• Avoiding overindebtedness
• Appropriate collections practices
• Transparent and responsible pricing

Avoiding Overindebtedness
A few months ago I was in Nicaragua visiting a branch office of a local
nonprofit MFI. The offices were stuffed with a crazy assortment of


household appliances. Loan officers’ desks were wedged between re-
frigerators and stacks of radios and microwave ovens. It turned out this
was all the stuff the “pro-poor nonprofit” organization had taken from
the homes of the poor.
Aaron Ausland61

For clients, overindebtedness reflects the risk of credit and relates to an experience
of someone who is “continuously struggling to meet repayment deadlines and re-
peatedly has to make undue sacrifices to meet his obligations.”62 While this def-
inition makes intuitive sense it raises a host of questions, such as, “If a client
chooses to take a loan knowing that she will have to make significant sacrifices
to make her obligations, should the MFI have not granted her loan?” For exam-
ple, microfinance clients I interviewed in Haiti sacrificed food purchases to make
loan repayments, with the knowledge that their investment in a business would
generate future profits and improve their well-being in the longer term.
From an MFI perspective, overindebtedness translates into client delin-
quency is measured by portfolio at risk (PAR). But from a client perspective
there is often great stress that is not translated into repayment problems. PAR
is a very insensitive indicator, and is also driven by many factors. A high port-
folio at risk may help an MFI recognize that it has a problem with overindebt-
edness, but it does little to help an MFI recognize in advance when the problem
is occurring. For group lending in particular, PAR is usually only captured when
a group fails to complete a payment rather than when an individual within the
group fails; thus, default only rises when clients are very highly stressed. In
India, for example, low PARs are used to argue against overindebtedness in the
current competitive context.
While multiple loans are often seen as an indicator of overindebtedness
from a client perspective, these loans may be very logical when the clients’ needs
are not being served by any one institution. Bobbi Gray of Freedom From
Hunger writers, “A client can appear overindebted with the one loan they have
and then there are those who have five loans, and they’ll indicate they are all for
different purposes and they are just proud they are not having to borrow from
friends or family.”63 Access to formal financial services may also lead to unex-
pected outcomes, with access to a loan from an MFI increasing people’s credit-
worthiness and therefore leading to increased borrowing from moneylenders.64
This example serves to demonstrate the complexity of informal financial mar-
kets and people’s livelihoods.
Overindebtedness is created where responsible lending goes wrong, or by ir-
responsible lending where one or more MFIs provide loans that exceed a client’s
capacity to repay without significant sacrifice. Four elements are key in avoid-
ing overindebtedness:


• Structuring products and services to ensure that they are appropriate for
their purpose and cash flow.
• Building in measures to help clients cope with emergencies when they
occur.
• Responsible lending that assesses capacity to repay and does not push
credit or mis-sell other products.
• Supporting clients via financial education helps them to understand the
risks and obligations related to borrowing.

The first step in avoiding overindebtedness is to ensure that products and
services are well suited to client needs. As discussed in the section on client value,
financial services have an important role to play in helping people reduce their
vulnerability and manage risk. Credit needs to be designed with this in mind,
and poorly structured it can serve to increase risk and vulnerability rather than
reduce it. Savings, insurance, and remittances are all important management
tools that can be useful when things go wrong.
Good client feedback mechanisms are important practically for MFIs to en-
sure that clients receive appropriate loans and that information comes back to
the MFI if problems are encountered. As previously discussed, there is a com-
mon mismatch between theory and reality, with MFIs lending on the assump-
tion that a loan is productively invested in a business, even when this is not
occurring. The story in Box 2.10 illustrates how easily clients can get into a
cycle of debt where the availability of repeat loans can create a cycle of bor-
rowing that does not necessarily benefit the clients.
Another source of overindebtedness is inappropriate or excessive lending by
MFIs. This situation arises when insufficient checks are made on a client’s ca-
pacity to pay, or when multiple lending makes these checks ineffective.
Assessing capacity to repay. A number of people I interviewed highlighted the
importance of MFIs having some form of assessment of capacity to repay (see
Boxe 2.11). Individual lenders, particularly those lending to businesses, often
conduct interviews with individual clients to assess their business strength, assets,
income sources, or cash flow. However, this approach is time-consuming and re-
quires skills on behalf of field staff. These steps are thus more suited to individual
lenders working with relatively high-value loans. Similarly the use of credit bu-
reaus has significant information requirements and may be costly for the MFI or
difficult to establish in many markets, due to a lack of client identity documents
and other formal information that may make the system difficult to operate.
Group screening. Most group-based lenders rely on peer screening to assess
capacity to repay. Where MFI staff are not able to do effective assessment of


Box 2.10 The Cycle of Debt and Borrowing
“I was visiting an MFI where in addition to their group loans, clients were per-
mitted to take complementary loans. Of a group of 20 to 22 women, 14 of
them had these individual complementary loans and they were all due at the
meeting I was attending.The MFI had decided to slow down the comple-
mentary loan program because PAR was rising.
“When they were informed that they could not get new loans on that
day, suddenly no one had the money for their payments—even though min-
utes before everybody had nodded yes that they have their payments.After
much heated discussion, it became clear that many of the women had sim-
ply borrowed the money that they needed for repayment from another
source, planning to get a new loan and repay the person they borrowed from
on the same day.When they learned there would be no more loans, it was
as if the music had stopped during musical chairs and everyone was left
without a seat. It was an extraordinary thing to watch.”
Lisa Khun-Fraioli, Freedom From Hungera

client capacity, then it is important for the MFI to take active measures to build
client understanding, group control, and responsibility for the lending process.
Solidarity groups, for example, must verify that other client loans are affordable
and commit to covering their repayments in the case of default. Lisa Kuhn
Fraioli describes the experience of Freedom From Hunger, which emphasizes a
strong client-led evaluation process as a critical part of group lending: “When
groups are formed, clients are taught a simple evaluation methodology to assess
investment opportunities, capacity to pay, and risks. This is usually comple-
mented with ongoing financial education that teaches clients about budgeting
and estimating their capacity for indebtedness.”65
However, in reality many organizations have reduced the role of solidarity
in their group lending, and effectively are lending to individuals within groups,
using security such as high compulsory savings or in some cases collateral in
place of joint liability. Screening by clients is often ineffective, with peer pres-
sure affecting loan sizes that are approved. Thus, this area is a particular chal-
lenge for group lenders, where detailed individual assessments are not possible
given the productivity levels of field staff.
Mis-selling. With increasing concern over interest rates, MFIs are seeking
other ways to generate profit. A narrow focus on profitability and limited client


Box 2.11 Credit Assessment at Swadhaar
Swadhaar (India) uses a two-part evaluation to determine whether to lend
and the amount to lend a prospective client. First, the loan officer (LO) deter-
mines whether to underwrite the loan based on whether a group is willing to
take the responsibility of its members. Second, an LO estimates a client’s ca-
pacity to pay based on sources of income, by asking a series of questions dur-
ing the group meeting itself. For business clients, LOs evaluate and crosscheck
sales, and for salaried clients, LOs verify the stability and amount of income by
doing an employer reference check. LOs use a loan matrix to determine re-
payment capacity based on the client’s income.This loan matrix takes into ac-
count a client’s historical repayment behavior, as well as feedback from other
clients and field staff.
To check overindebtedness of its clients, Swadhaar captures data on its
clients’ borrowings and has signed up with a credit bureau to track a client’s
credit history with other microfinance institutions.
Swadhaar also conducts financial education, covering topics such as budg-
eting, managing cash flows for emergencies, and large planned expenditures.
Source: Shweta Pereira, chief manager, credit and riska

focus can lead to the pushing of inappropriate products and mis-selling of other
financial services. Many organizations, for example, bundle credit life insur-
ance with their loan products. This purports to be a benefit for clients, but pri-
marily serves to protect the MFI from default by paying off the client’s loan to
the MFI; premiums are often excessively high. The recently launched Social Per-
formance Indicators for micro insurance go some way to address this.66
Responsibility to avoid overindebtedness also lies with clients. Given the
low levels of education and financial literacy of microfinance clients, MFIs have
a responsibility to ensure that clients fully understand the risks and obligations
of credit. Clients should also be well informed about the service that they should
expect, or field staff can take shortcuts or push inappropriate loans or other
products. The following quotes from clients of a Bolivian microfinance institu-
tion, CRECER, further underscore this point.
“My children became CRECER borrowers when they moved to town, but
[taking out a loan] is not for everyone because some don’t know how to use
money and so it gets them into trouble,” said Juana, age 53. Julia, age 46, in-
dicated that “taking out a larger loan to me means success, but more debt also
depends on if you manage your money well.” Elsa, age 59, shared, “If you need


money, CRECER is good. But you must also know how to administer the
money well or it can be bad.”67
Opportunity International, for example, an international organization
working in more than 20 countries, sees investment in financial literacy as a
critical component: “Clients are better empowered to make informed financial
decisions and to exercise those decisions with confidence.”68

When Things Go Wrong
Zero delinquencies have always concerned me because that’s not quite
how the world works. Businesses are sometimes unable to generate the
cash flow to make a payment. Given that we know that that’s the case,
if people are making payments, how is that happening? Who’s actually
paying for these businesses? What are they drawing down? What pres-
sures are being brought to bear?
Alex Counts, Grameen Foundation69

Even if an MFI takes care not to overindebt its clients, things can go wrong for
clients, and their debt can become burdensome. One of the defining features of
poverty is the inability of poor people to cope with the inevitable problems that life
throws at them. Increasing emphasis on savings and, to a much more limited ex-
tent, insurance and remittances builds client resilience and provides the means to
respond when things go wrong. However, credit leaves clients in debt, and the way
in which MFIs respond to this vulnerability in the services they offer and in delin-
quency management makes a huge difference to their social outcomes. These is-
sues are critical considerations for MFIs that seek to be responsible lenders.

Contractual Obligation or Flexibility?
Striking the right balance between a client’s contractual obligation—and the fi-
nancial viability of an MFI—and a need to protect clients from harm is a criti-
cal point. Many MFIs take a zero-tolerance approach to delinquency, arguing,
for example, “The practice of banks and MFIs realizing security in the devel-
oping world happens for the same reasons that banks pursue these remedies in
the developed world—to contain credit losses and to maintain a sense of com-
mitment and discipline in their borrowers.”70
Microfinance, however, is not the same as formal-sector banking. Clients
are more vulnerable and less financially literate, and the information available
to assess capacity to repay (credit bureau, employer reference, and so on) is far
less reliable in the informal sector. In addition, most MFIs work in contexts
where the social safety nets such as those in Europe or the US are not present.


It is impossible for MFIs to assess risk to the same extent as formal banks; there-
fore, it is important that responses to genuine client problems are more flexible.
However, many MFIs have rigid systems that do not take into account clients’
vulnerability. When things go wrong for clients there is no flexibility on the part
of the MFI. Without resources to draw on, clients have to resort to selling as-
sets or borrowing money from money lenders to repay.

When I fell seriously ill (due to pregnancy) and the medical bill came up
to 25,000 FCFA, I got a loan in the amount of 70,000 FCFA. After the
second reimbursement, however, I could no more keep up with those re-
imbursements. I therefore asked the program officials to offer me a
grace period so that I could pay my debt off. But they refused, arguing
that other women might do the same thing in order to escape the
weekly reimbursements. When he heard about the situation, my hus-
band managed to find the amount remaining to be paid and then asked
me not to participate anymore. He thought that the program is not
meant to protect people from shame; rather the opposite.71

The line is often very fine between a response that resolves issues, helping
clients recover and remain with the MFI, and one that may succeed in achiev-
ing repayment but leaves the client worse off. Credit programs that apply zero
tolerance with little flexibility risk harming their clients. Most MFIs see delin-
quency management as being critical to success, and send out a strong message
to staff that late payment should not be tolerated. This approach is supported
by incentive schemes that often drastically cut payouts to staff should the port-
folio at risk rise above quite a low level (see Box 2.12).

Box 2.12 Branch Accountant in MFI Branch, India
Zero PAR is the most important criterion on which our branch is judged, and that
is why all/most of our branch staff go to any defaulting/potential defaulter’s house on
the same day and try and get the payment.To us, Zero PAR is simply about ensuring
100% on-time repayments always, and if we cannot get it from clients, we have to
make over the delinquent payment from our resources and then recover from clients.
Our institution will not accept anything less than 100% on-time repayment, and our
incentives are tied to not only loan disbursement but also 100% on-time recovery.
Source: Ramesh S. Arunachalam, Microfinance India blog, December 27, 2010, www.microfinance-in-
india.blogspot.com


Covering Up Problems in Groups
This issue is particularly common in group lending where group solidarity
masks problems and high repayment rates can be achieved despite severe neg-
ative experiences by individual clients.
Clearly, it is important to recognize that the group mechanism is very frag-
ile and that many MFIs quite rightly fear that the whole group or many groups
will stop paying if the MFIs start granting some clients tolerance. This very real
risk has to be managed as an MFI seeks to find a more compassionate solution.
CARD in the Philippines, an MFI with over a million clients, has successfully
moved away from a zero-tolerance approach. Annie Alip of CARD explains,
“We held dialogues, branch by branch, with those who were having repayment
difficulties, and came to agreements with the most convenient way for them to
repay. Surprisingly, many came to these dialogues, proving that many clients
were not willful defaulters; it was just life happened, they were vulnerable and
they did not have safety nets.”72

Appropriate Collections Practices
The pressures on me are so high and it is impossible to move at the
very fast pace of growth all the time. I worry what will happen if peo-
ple do not pay back loans as I know their income stream is weak and
unpredictable.
Indian MFI branch manager73

While the need to ensure repayment and low portfolio at risk is core to the suc-
cess of microfinance as a business, care needs to be taken not to incentivize staff
or clients to use coercive methods to collect repayments. It is also essential to
recognize that when things go wrong in the lives of clients, and they are under
severe financial strain with none of the safety nets common in the Western
world, applying strong pressure to repay can be damaging.

Avoiding Coercive Behavior by Staff
There was strong support among practitioners I consulted for the assertion that
deterioration of relationships between staff and clients in many organizations
is leading to a mismatch between client needs and services delivered, poor com-
munication and transparency, and inappropriate collection practices by staff.
Pressure on staff to ensure high repayment rates often creates an overbear-
ing or coercive approach from field staff—often male staff and female clients
(see Figure 2.3). In the worst cases we see MFIs that achieve a 100% repay-
ment rate through practices such as holding clients in a meeting until all money
has been collected; clients with repayment problems leave the meeting to “find”


Figure 2.3 Times of India Account of the Kidnapping of an MFI Customer’s Child

the money and return after an hour or so. Where does the money come from?
Perhaps from savings or from a friend, but more likely a money lender or from
selling assets. Organizational incentives do not ask this question, but rather just
focus on whether the money is repaid regardless of how it is repaid.
Concern over perceptions of coercive behavior of staff toward clients is
growing, and has led to the adoption of appropriate collection practices as one
of the SMART Campaign client protection principles,74 whereby organizations
commit to ensuring that “debt collection practices of providers will be neither
abusive nor coercive.” The principle needs to be interpreted broadly, and calls
for awareness of the experience of clients. For example, in Uganda rural women
were quite sensitive to the attention the loan application process could draw
from neighbors. They felt that this was humiliating and a violation of their pri-
vacy. “When the photographers come to take pictures and assess what you own,
other people sit there commenting that you’ll fail to pay the loan and you be-
come the laughingstock,” said one woman respondent.75
Sometime ago I heard about a team of market researchers in Uganda who
were talking to clients of an MFI about what they liked and disliked about the
services. The clients responded angrily about their treatment at the hands of
field agents: “They are devils. . . . All they care about is getting their money
back.” This story from one of the most competitive microfinance markets is
extreme but not atypical. In my own work I have seen MFIs in different con-
texts where to a greater or lesser degree the focus of the organization on the
practicalities of getting loans out and getting them back has led to a weak rela-
tionship between field staff and clients. Now, when I talk to clients I often use
a devils-or-angels voting scale (see Figure 2.4)—asking clients to indicate where

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