Tuesday, April 03, 2007

Microfinance – The Way Forward for the Poor

Microfinance also referred to as micro credit is one of the key strategies currently being used by development agencies in the reduction of poverty.It involves the provision of a broad range of financial services such as deposits, loans, payment services and insurance to low income households without the often complex formalities associated with accessing similar services from the formal financial sector. The United Nations Capital Development Fund UNCDF has identified microfinance as an effective means of reducing poverty in developing countries, thereby achieving its commitments its programme of action for least developed countries and the Millennium Development Goals. Another reason why microfinance is so highly favoured by aid agencies is that some of the money provided is recovered as opposed to money provided through the usual grants process. In India microfinance is very common considered to be the most effective tool in alleviating poverty. The Asian Development Bank has developed a strategy for microfinance. One of the objectives of this strategy is the use of microfinance as a vehicle for bringing the poor especially women into the formal financial system.

The United Nations Capital Development Fund has embarked on a programme aimed at identifying and seeking to remove the key constraints to an inclusive financial sector. This involves intensive capacity building of the financial regulatory and supervisory authorities. Microfinance was identified as one of means by which this can be achieved. It offers the same services being offered by the formal financial institutions without all the conditions that effectively exclude the poor from using such services.

Sierra Leone was the first country to start the implementation of the above programme. The government of Sierra Leone fully supported this programme, hoping it would ensure that the poor are able to fully participate in the financial activities of mainstream society. In 2004 UNDF in partnership with other international donor agencies like Cordaid launched a US$10.3 million programme aimed at building an inclusive financial sector in Sierra Leone.

The use of microfinance in Sierra Leone is nothing new. The most commonly used form of micro finance in Sierra Leone is “Osusu” and this dates as far back as the beginning of the 20th century. A group of people form a savings club. Members of the savings club contribute the same amount at regular intervals and take it in turns to “draw out” the amount collected. Money saved this way is usually for a specific purpose for example school fees, setting up of a business or for the payment of rent. One of the main advantages the traditional osusu has over the more advanced method of microfinance is that there are no additional charges such as interests and administrative charges. However with both systems the main form of collateral is social collateral. This is based on trust. Members trust each other and often cite this as the reason for not defaulting with their payments.

Microfinance is an informal way of accessing a range of financial services by the poor who lack to necessary requirements, usually needed to access credit from the formal sector such as banks and other institutions. Banks and other lending institutions operating within the formal sector have very stringent loan conditions and most poor people are unlikely to meet such conditions. The poor are often seen as high risk customers, who are unable to provide marketable collaterals for loans. The high cost involved in administering such loans is another reason for the formal sector’s reluctance to sell its financial services to the poor. This is also the case in relation to small businesses. This is why the poor often have to rely on relatives or turn to loan shacks who lend them money at extortionate costs.

Microfinance generally provides the poor with improved financial facilities that suit the way they usually organise their financial activities. The amount of paper work involves is kept to a minimum. Apart from providing the poor with credit facilities, microfinance provides the poor with insurance which helps them manage risks, enable them to build their assets, increase their income and hopefully live a better life.

Some banks are not blind to the fact that they are missing out on a large number of potential customers by failing to offer their services to the poor. In Sierra Leone this could be as high as 70% of their potential clients. The National Development Bank is one of the formal institutions that had successfully set up a microfinance section to meet the needs of the poor. The amount available to clients was offered in tiers. Initially 100,000 leones worth of credit was made available to the client. Once this amount was paid the client was then able to access the next credit level of 200,000 leones until the credit ceiling of about 500,000 was reached. This was the bank’s method of ensuring that large sums of money were only offer to creditworthy customers. Administrative charges were taken from the initial loans. In the case of The National Development Bank this was 15% of the amount borrowed. This means that someone borrowing 100,000 leones only actually received 85,000 (less 15,000) leones in interests.

The National Development Bank did not provide its microfinance customers with insurance services. What it offered was a “buffer”, this meant that some of the money borrowed was retained by the bank and later made available to the customer during periods of financial hardship.

Unfortunately though very successful this service has recently been phased out by the NDB, as the bank is currently winding down its business activities. There is definitely a market for microfinance in Sierra Leone. It is however very important that the additional charges such as interests and administrative charges are kept to a minimum, otherwise the poor would find themselves in a situation in which they are yet again being excluded from the formal financial market because they are unable to pay high charges