TOPIC 3: MICROFINANCE INSTITUTIONS AND OPERATIONS

By the end of this topic a learner should develop an understanding about the:
1. Nature of lending in MFIs
2. Different types of MFIs
3. Credit markets
4. Digitization of microfinance
5. Capital funding

The mission for the funding institutions is to help MFIs operating more efficiently and be more
effective. They provide each partner with financial products and services that are tailored to meet
their needs.

A goal is to ensure the partners are moving their clients out of poverty and to foster good practices
for measuring the progress of the individual’s movement across poverty lines. MFIs must show
results, yet many do not have the tools to evaluate how well they are fulfilling their mission of
reducing poverty, reaching people excluded from financial services, empowering women, or
promoting community solidarity. That´s why they should also equip microfinance institutions with
tools to measure their clients’ progress out of poverty.
Built on the learnings of previous efforts in the microfinance industry they can develop the
operational methods in reaching the clients. Innovative financing solutions and strategies to expand
the capacity and efficiency of the MFIs provide a direct impact on the lives of the poor, and
advancing the microfinance industry as it moves toward even higher standards in terms of anti-
poverty impact and financial performance.

Micro Financial Institutions

Poverty is the main cause of concern in improving the economic status of developing countries. A
microfinance institution is an organization that offers financial services to low income populations.
Almost all give loans to their members, and many offer insurance, deposit and other services.

A great scale of organizations is regarded as microfinance institutes. They are those that offer
credits and other financial services to the representatives of poor strata of population (except for
extremely poor strata).

Microfinance is increasingly being considered as one of the most effective tools of reducing
poverty. Microfinance has a significant role in bridging the gap between the formal financial
institutions and the rural poor. The Micro Finance Institutions (MFIs) accesses financial resources
from the Banks and other mainstream Financial Institutions and provide financial and support
services to the poor.

MFIs are the pivotal overseas organizations in each country that make individual microcredit loans
directly to villagers, micro entrepreneurs, impoverished women and poor families. An overseas
MFI is like a small bank with the same challenges and capital needs confronting any expanding
small venture but with the added responsibility of serving economically-marginalized populations.
Many MFIs are creditworthy and well-run with proven records of success; many are operationally
self-sufficient.
Various types of institutions offer microfinance: credit unions, commercial banks, NGOs (Non-
governmental Organizations), cooperatives, and sectors of government banks. The emergence of
“for-profit” MFIs is growing. In India, these ‘for-profit’ MFIs are referred to as Non-Banking
Financial Companies (NBFC). NGOs mainly work in remote rural areas thereby providing
financial services to the persons with no access to banking services.

The term “transformation,” or commercialization, of a microfinance institution (MFI) refers to a

change in legal status from an unregulated nonprofit or non-governmental organization (NGO)
into a regulated, for-profit institution. Regulated, transformed organizations differ from nonprofits
in that they are held to performance and capital adequacy standards and are supervised by a
financial authority, typically the central bank of the country where they are registered.
A transformed MFI also attracts equity investors. The equity investors want to ensure that the
values of their investments are maintained or enhanced and elect Board members who share a
common vision for the new for-profit institution.
Among transformed MFIs, varying classifications of regulated institutions exist, the strictest being
banks — rural banks and thrift banks — followed by non-bank financial institutions. Different
countries have varied names for these regulated MFIs.

The microfinance sector consistently focuses on understanding the needs of the poor and on
devising better ways of delivering services in line with their requirements, developing the most
efficient and effective mechanisms to deliver finance to the poor. Continuous efforts towards
automation of operations is steady improving in efficiency. The automated systems have also
helped accelerate the growth rate of the microfinance sector.

The goal for MFIs should be:

1. To improve the quality of life of the poor by providing access to financial and support
services;
2. To be a viable financial institution developing sustainable communities;
3. To mobilize resources in order to provide financial and support services to the poor,
particularly women, for viable productive income generation enterprises enabling them to
reduce their poverty;
4. Learn and evaluate what helps people to move out of poverty faster;
5. To create opportunities for self-employment for the underprivileged;
6. To train rural poor in simple skills and enable them to utilize the available resources and
contribute to employment and income generation in rural areas.
 Microfinance industry structure

The Grameen Model- Working method for microfinance institutions

The Grameen Bank of Bangladesh has developed a joint liability model that its MFIs are using
suited for local conditions.

When choosing a village, the MFI conduct a comprehensive survey to brief the potential for
operations and the local conditions in a village. The MFI are evaluating some key factors like
village population, degree of poverty, road accessibility, political stability and safety. When a
village has been selected, the MFI introduces its mission, methodology and the services they are
offering.

After the informational presentation interested women are gathered in group formations. They
have to be in the age between 18 and 59. The women put them self together in groups of five to
serve as guarantors for each other. Earlier experience has shown that a group of five persons is
small enough to create group pressure between the members, enforcing them to be loyal to each
other. In case someone of the group members are not able to repay the loan the group is big enough
to help with the payments. The company does not influence the selection of group members nor
the decision regarding the income generation activity nor the loan amount they intend to take.
Group members must live close to each other and cannot be related to each other.
 If a borrower defaults on her loan, the entire
group typically is penalized and sometimes
barred altogether from taking further loans. This
peer pressure encourages borrowers to be very
selective about their peer group members and to
repay loans in full and on time.

Then the group training begins, usually as a five-day program. The purpose is to educate the
members in the procedures of the financial products, delivery methods, calculation of interest rates,
business development skills and how to sign their names. The members are also taught in quality
management, to identify an income generation activity, how to set prices and how to market. They
field staff also build a culture of credit discipline and collective responsibility. The field staff
makes sure the members qualifies for the program and collect data for future analysis. Within the
village, a center is created collecting the groups. The center is responsible for the payments of all
groups, enabling a dual liability system. When the village center is created the financial
transactions can begin.

The groups meet weekly in the village center where they can discuss new loan applications, loan
utilization, and community issues. The field staff of the MFIs conduct the meetings with rigid
discipline in order to sustain the credit discipline of the group. All financial transactions are
conducted during the meetings.
Microfinance is a relatively new segment of the market economy that is why institutions created
in this segment have short experience in their activities, and their personnel is not sufficiently
experienced and qualified.
Taking this into consideration, staff of these institutes is recommended to follow the internationally
recognized principles of microfinance:
 thorough examination of potential clients of the microfinance institution;
 thorough estimation of business viability and also factors which can positively or
negatively affect the results of work in specific conditions;
 thorough registration of documents and contracts related to loan issuance and microfinance
services providing;
 keep in touch with client in combination with monitoring of the terms of paying a credit,
interests payments and with the aim to find out potential and real problems;
 setting of interest rates for microfinance services compatible with market ones;
 quick reaction to any problems which can complicate the perspectives of getting of issued
credit payed back.