An Overview,

Fundamental
Concepts, Principles
and Characteristics,
best practices of
Microfinance

Tejhari Ghimire
 Resource contents

• An Overview of Microfinance Sector

• Fundamental Concept of
Microfinance
• Key Principles of microfinance
• Characteristics of Microfinance
• Best practices of microfinance

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 Overview….Country
Scenario
• More than 31% of the Nepal's
population lives in extreme poverty.
• Informal financial system remains
dominant
• The sector has experienced growth of
microfinance institutions (MFIs) and
significant progress in terms of clientele,
outreach, savings and credit
management.
• Microfinance Development Banks (22)
are providing microfinance services to
8,46,517 rural poor women across 57
districts through self-managed centers
and groups[1];
[1] Source: NRB, Mid-July, 2011

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 Overview….Country
Scenario
• 10,558 Savings and Credit Cooperatives and Credit
Unions provide services to 14,06,021 clients (female
651,512 and male 754,509) in 75 districts[1] ( this
includes urban saving and credit cooperatives that may
not represent microfinance services);

• Small Farmers Cooperative Limiteds (SFCLs: 243) are

providing financial services to 1,69,686 clients-SKBBL,
Mid-June, 2011

• 38 Financial Intermediary NGOs are providing financial

services to a further 454,026 predominately poor people[2]
.

• This shows that 25,95, 046 of the rural population have

access to microfinance services in Nepal, which
contributes 10.25 % of the total population and 33.05 %
of those is living below the poverty line. This is the 20%
reduction in total clients of saving and credit clients. It is
assumed that 20% urban population do not represent
MF clients that was also included in the total clients of
saving and credit coops.

[1]09/16/12
Department of Cooperative, 2011
[2] Compiled by CMF, 2011
 Overview….Country
Scenario
• A total of 2,048,742 of the rural population
have access to microfinance services in
Nepal, which contributes 8.09% of the
total population[1] and 26.1% of those is
living below the poverty line[2],

• Of which 1,233,058 are women,

representing 9.73% of all Nepalese
women[3]. Data shows that the majority of
microfinance service recipients are
women

• Nevertheless, the women led MFIs are

approximately 2545 saving & credit
cooperatives.

• [1] Total population about 25,296,537 as of 2005 Projection ( Informal Sector Research
and Study Center: 2004)
• [2] 31% of total population ( NLSS:2003/04)
• [3]( NIDI, CMF: 2006)

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 Fundamental concepts

• Meaning of Microfinance
• Myth and Facts of Microfinance
• Why microfinance
• Goal of microfinance

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What is microfinance?
 Definition

• Microfinance is the provision of

financial access to low-income
people or solidarity groups
including consumers and the small
entrepreneurs , who traditionally
lack access to banking and related
services.
 Meaning of Microfinance
• "Microfinance is the supply of loans,
savings, and other basic financial
services to the poor." (CGAP).

• A microfinance institution (MFI) is

defined as an organization that provides
microfinance services, ranging from
small non-profit organizations to large
commercial banks.

• CGAP broadly defines MFI as any

organization—credit union, downscaled
commercial bank, financial NGO, or
credit cooperative that provides financial
services for the poor.

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 Myth and Facts
• Poor people do not repay
loan
– Myth or Fact

• Poor people can not pay the

interest rates necessary to
cover the cost of delivering
the services
– Myth or Fact

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 Myth and Facts

• MFIs cannot access commercial

sources of funding
– Myth or Fact

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 Myth and Facts

• MFIs cannot reach the very poorest

of the poor only through credit
– Myth or Fact

• Financial sustainability is necessary

for an MFI to reach large number of
people
– Myth or Fact

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 Myth and Facts

• MFIs only extend services to the

very poor
– Myth or Fact

• Microfinance alone does not

alleviate poverty
– Myth or Fact

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 Myth and Facts

• The Goal of microfinance is

institutional sustainability
– Myth or Fact

• Many microfinance operation will

not become sustainable
– Myth or Fact

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 Myth and Facts

• A solid understanding of the facts

about microfinance is critical to
making good investment decision

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 Why Microfinance

• Development of micro-enterprise
– Microenterprise creates job
• Supply of goods and services to
low- income population is increased
• Increase the productive use of
capital

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 Goal of Microfinance

• Viability
– Sustained long – Retained
term viability earnings
through profit,
– Commercial
not donor
capital deposits
funding

• Outreach
– Reach more
people with
quality services

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 Goal of ….Qualities of
outreach

• Depth of • Quality of
outreach services
– MFIs with deep – Liquidity
outreach reach
– Convenience
very poor or hard
to reach clients – Availability
– Flexibility of
purposes
– Freedom to borrow
• Scale or save
– The number of
people with
• Indicators of
access to MFI quality services
services – Demand
– Large scale
outreach is
necessary to
reach the majority
of potential clients

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 Viability

Financial Institutiona
l
The basic Organizatio
cost of ns that are
operation well
are covered managed
by MFI and staffed
revenue, for long-
not term
subsidies success
Both financial and
institutional viability are
necessary to support the
goal of extending services
to the large number of
people over time
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 Benefits of financial
viability
• Services can be maintained in the
future without being subject to
unpredictable fluctuations in donor
funding

• Access to commercial sources of

funding

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 Self-sufficiency
Operational Self Financial Self
Sufficiency Sufficiency
Depreciation, loan loss
All expenses
provision expenses and
cash operating covered by income
expenses from operations

•Loan loss reserves •Loan loss reserves

•Salaries •Salaries
•Rent •Rent
•Depreciation of •Depreciation of Fixed
Fixed Assets Assets
•Cash cost of funds •Cash cost of funds
•Inflation on equity
•Value of subsidies
•Cost of capitalization

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 Level of Financial Viability
• Level I: Characteristics
– MFIs that have not achieved
operational self sufficiency
– They rely on outside donation for
continued operation
– Revenues fall short of operating
expenses
– Inflation will erode the loan fund
– Poor performers are subject to erosion
of loan fund through delinquency and
default
– Many have high operating costs, are
reluctant to charge sustainable interest
rates, and have high delinquency and
default rates, especially older
organization
• It is estimated that 90% MFIs operate at
level I
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 Level of Financial Viability
• Level II: Characteristics
– MFIs that are operationally, but
not financially, self-reliant
– They apply proven principles,
are generally efficient, have
higher client to staff ratios, an
increasing scale of operation,
and good control of delinquency
and default
– Interest and fee income cover
operating expenses, but
inflation can erode equity
– Funds are borrowed on terms
near, but still below, market
rates
• Level II organizations can vary
widely from those that rely on soft
money.
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 Level of Financial Viability
• Level III: Characteristics
– MFIs that are financially self-
sufficient
– Operation is fully financed from
retained earnings, client savings,
or commercial funds
– Interest rates and fees cover the
full cost of service delivery and
return on savings
– Interest rates and fees cover the
real cost of funds
– MFIs can increase their equity
base through profits and attract
outside equity participation
• So far only a few MFIs have reached
at Level III, but many poised to do
so.
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 Institutional Viability
• Capacity
• Governance
• Types
– Specialized financial institutions

– Specialized services within commercial

financial institutions

– Non-governmental organization (NGOs)

– Credit unions or other member owned

institutions

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 Principles of Microfinance

• Consultative Group for Assistance

to the Poorest (CGAP)- 2004
(Principles)

• Key operating principles of

microfinance

• International Credit Union

Operating Principles-1984

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Consultative Group for Assistance
to the Poorest (CGAP)- 2004

• Poor people need a variety of financial

services, not just loans.

• Microfinance is a powerful tool to fight

poverty.

• Microfinance means building financial

systems that serve the poor.

• Microfinance can pay for itself, and must

do so if it is to reach very large numbers
of poor people.

• Microfinance is about building

permanent local financial institutions.

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 Consultative Group for
Assistance to the Poorest
(CGAP)- 2004
• Micro-credit is not always the
answer.
• Interest rate ceilings hurt poor
people by making it harder for
them to get credit.
• The role of government is to
enable financial services, not to
provide them directly.
• Donor funds should complement
private capital, not compete with it.
• The key bottleneck is the shortage
of strong institutions and
managers.
• Microfinance works best when it
measures—and discloses—its
performance.
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 Key operating principles of
microfinance
• Understanding the Market
– A successful MFI understands
its market and designs products
that serve its clients
• Streamlined Operations
– Streamlined operations help
MFIs make efficient use of
resources and keep cost low
• Informal Sector Practices
– This practices help an MFI
manage risk, motivate
repayment, and lower
administrative costs.
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 Key operating principles of
microfinance
• Repayment Incentives
– The ability to get another loan
when it is needed is a powerful
incentive for the clients to repay
current loan.
• Saving Services
– Saving services should be
liquid, secure, convenient, offer
competitive returns, and not to
be limited to borrowers.
• Viability and Growth
– MFI staff should be focused on
achieving efficiency, financial
productivity, and financial
viability.
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 Key operating principles of
microfinance
• No Delinquency tolerated
– Successful MFIs do not tolerate
delinquency
• Sustainable Interest Rates
– Interest must be set high
enough to cover all costs of
delivering services
• Linkage to Financial Market
– Leveraging resources from
commercial markets is essential
to achieving significant outreach

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 International Credit Union
Operating Principles-1984

• Democratic Structure
– Open and volunteer
membership
– Democratic control
– Non-discrimination
• Service to Members
– Service to members
– Distribution to members
– Building financial stability

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 International Credit Union
Operating Principles-1984

• Social Goals
– Ongoing education
– Cooperation among
cooperatives
– Social Responsibility

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 Characteristics of
Microfinance
• Mostly it is collateral free
• MFIs go to clients rather than
clients go to MFIs
• Simplified savings and loan
procedures
• Small sizes of loans and
savings
• Repeat Loans
• Loan size increases in the
repeated loans or subsequent
cycles

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 Characteristics of
Microfinance
• Interest rate is usually in
between money lenders and
formal banks
• Free use of loans (no
restrictions on specified
purpose)
• Repayment considers incomes
from business as well as other
sources
• Loan and savings products
within manageable numbers

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Best
practices of
Microfinance

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 Best practices of MFIs

• Build effective
Management Information
System (MIS)
• Reach large number of
clients (Vision of growth)
• Promote savings services,
diversify savings products

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 Best practices of MFIs

• Offer services that fit the

clients’ needs, diversify
loan products
• Simplify loan products to
reduce operational costs
• Motivate clients to repay
loans, focus on high
repayments

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 Best practices of MFIs

• Attain financial
sustainability by charging
sufficient (above market)
interest rates and fees
• Involve clients when
designing services
• Promote effective
governance, characterized
by democratic and
transparent decision-
making
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 Best practices of MFIs

• Target clients properly

• Focus on financial
services only
• Develop institutional
linkages.

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 Lessons learned from
Women managed Savings
and Credit Cooperative
• Lesson -1 Women managed
saving and credit cooperatives
are the best microfinance
institutions that can exist even in
an insurgency situations

• Lesson -2 Adaptive mix of

training and technical assistance
can ensure capacity building
even in case of uneducated/rural
women owned institutions:

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 Lessons learned from
Women managed Savings
and Credit Cooperatives

• Lesson-3 Participatory
monitoring helps MFIs to
develop need based products
and services

• Lesson-4 Enhanced
capacity of MFIs creates
demand for enterprise
development services and
entrepreneurs

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 Lessons learned from
Women managed Savings
and Credit Cooperatives

• Lesson-5 Installment
repayment system helped to
reduce delinquency rate

• Lesson-6 Healthy
competition among MFIs
encourages self-regulation in
the market

• Lesson-7 Rural and only literate

women managed saving and
credit cooperatives are able to
attain OSS 108% and FSS 92%.
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