2 Microfinance

MICRO FINANCE AND TRADITIONAL
BANKING
 Providing microfinance services is very
different from providing traditional banking
services
 Various models have been developed and
adapted to deal specifically with the unique
requirements of microfinance clients.
June 18, 2024 Dr Macha J 1

DIFFERENCES BETWEEN MICRO FINANCE
AND TRADITIONAL BANKING
 Size of Loans
 The micro-finance institutions have relatively small
capital base than commercial banks. MFIs therefore
deal with small loans relatively to their size.
 The table below indicates minimum core capital
requirements for banks and financial institutions in
Tanzania (BAFIA, capital adequacy regulation, 2015)
 The Act gave the Bank of Tanzania powers to
license, regulate and supervise banks and financial
institutions

DIFFERENCES BETWEEN MICRO
FINANCE AND TRADITIONAL BANKING
S/No. Types of Institutions Minimum Core Capital
1 Fully-fledged Banks
Commercial Banks Fifteen billion shillings

Cooperative Banks (Nation-wide network) Fifteen billion shillings
2 Limited Scope Banks

Microfinance Banks Five billion shillings
Community Banks Two billion shillings
Cooperative Banks (Regional) Five billion shillings
3 Specialized Institutions
Development Finance Institutions Fifty billion shillings
Finance Lease Companies One billion shillings
Housing Finance Companies Fifteen billion shillings
Tanzania Mortgage Refinance Company Six billion shillings
(TMRC)
Merchant Banks Twenty five billion shillings
Islamic Banks Fifteen billion shillings

 Microfinance regulations 2019,

requires:
 SACCOS to have a minimum
capital for category A – TZS10
million and category B - TZS200
million
 Non-deposit taking MFIs – TZS 20
million
 Operations and requirement
Microfinance operations are simpler than
commercial banks operations. Commercial
banks have complex loan procedures that
take long to process and require a lot
information to be provided

 Cost of loans
Generally, MFIs charge high interest rate compared
to conventional banks because the funding could
be expensive if no donor funds or subsidies
and they deal with relatively risky set of
borrowers with collateral free loans
In addition, MFIs charge high interest rates
because their borrowers have no sizeable
overheads and can afford to pay. Due to their
size, follow up costs are high. Commercial
interest rates are relatively lower.
To some MFIs interest rate

ranges from 3% to 20% per
month (NMP, 2017).
Commercial banks interest
rates are relatively lower.

 Type of borrowers
MFIs target the poor and unbanked low
income individuals. By the very nature of the
business, micro finance institutions face high
administrative costs per loan. Also intensive
monitoring efforts are required to ensure
payment. Most of the micro entrepreneurs do
not keep financial records and assessment of
performance is difficult and costly.

 On the contrary conventional commercial
banks target customers who can afford bank
conditions. Banks prefer large businesses
where they can obtain big interest income.

 Collateral
The banking and financial institutions act
requires lending be subject to collateral.
Micro-finance has other forms of collateral

which are substitute and alternative forms of
collaterals (Joanna L, 2013)

 Door step’s financial services
Most of the services provided by commercial
banks are bank door services, which means
the clients have to go to the banks to avail
financial services. Most of the services
provided by Microfinance institutions are door
step services, which means the staffs of the
MFIs deliver their financial services at client’s
door step.

 Lending models
Microfinance use both individual and group
lending models, but conventional banks commonly
use individual lending model; e.g. a group 5-
individuals from a particular community may
borrow individual loans and guarantee each other.
Thus, they’re effectively borrowing the loans
together since if one person cannot pay back his
or her loan, then others have to pay it back or they
are all at the risk of defaulting and never borrow
from the MFI again
 Compulsory savings
 It is also known as compensating balances or
forced savings that represent the amount of
fund which must be contributed by the
borrower as a condition for receiving a loan
 Many MFIs require clients to hold a balance
stated as a percentage of the loan in savings
for first or subsequent loans (or both)
 Compulsory savings are not available for
withdrawal while a loan is outstanding
 compulsory savings act as a form of collateral
 Most compulsory savings are available for
withdrawal only at the end of the loan term,
provided the loan has been repaid in full

COMPULSORY SAVINGS
 MFIs imposes compulsory savings so as to:

 Enhance clients’ savings discipline
 Protect clients’ savings from less important uses
 Act as a form of collateral
 Serve as an important source of loan capital to
MFIs
 Provide a stable source of funds to MFIs
because they are illiquid
 Obtain less costly funds than liquid savings
services
COMPULSORY SAVINGS
 The drawbacks of Compulsory savings to clients
 limited access to their savings
 They might be forced to borrow from expensive
sources to meet emergencies
 Lose access to credit incase circumstances force
them to withdrawal the savings
 Part or all savings could be lost due to group
members’ default
 It may exclude the very poor

PROVIDERS OF MICROFINANCE SERVICES
 Formal sector institutions
 Informal sector institutions

FORMAL SECTOR INSTITTUTIONS
 These are institutions, which are subjected

not only to general company laws and
regulations but also to specific banking
regulations and supervision. These include
 Commercial banks
 Savings banks
 Rural banks
 Postal savings banks

FORMAL SECTOR INSTITUTIONS
 Cooperative banks
 Development banks
 Finance companies
 Building societies and Credit unions
 Community banks
 E.g. CRDB, Akiba bank, TPB, NMB, Access
bank, Finca, EFC, DCB bank

INFORMAL SECTOR INSTITUTIONS
 Informal financial intermediaries operate

outside the structure of government
regulation and supervision.
 Often they do not comply with common book
–keeping standards and are not reflected in

official statistics on the depth and breadth of
the national financial sector.
 It is an unorganized ‘nuisance’ sector whose

members, for example do not pay any form of tax, on
the other hand it provides jobs and increase incomes
of the most vulnerable groups in a city – the very low
income group.
 More than 60 per cent of the world’s employed
population are in the informal economy (ILO, 2018)
 In Africa, 85.8 per cent of employment is in the
informal (ILO, 2018)
 Informal sector in Tanzania accounts for about 70 per
cent of employment and 58 per cent of gross national
income (URT, 2008)
 Savings and loan associations

 Rotating savings and credit associations
 Non-registered self-help groups
 Individual moneylenders
 Pawnbrokers
 Traders and shopkeepers
 Families and friends

 Why the poor or low income individuals use

the informal credit market?
 It does not require a license
 It facilitates very small savings behaviour
 It provides localized services
 It has personalized services
 It has high repayment rates
 It encourages community participation in
other fields of development
TYPES OF FINANCIAL SERVICE
PROVIDERS IN TANZANIA
 The national microfinance policy of Tanzania
identifies two types, namely:
 Formal microfinance service providers such as banks
and financial institutions; SACCOS; microfinance
companies, financial NGOs, Government Funds and
Programmes
 Community financial groups such as Community
Based Organizations (CBOs), VICOBA, Village
Saving and Loan Associations (VSLAs), Rotating
Saving and Credit Associations (ROSCAs), money
lenders, and other financial related service providers

SELF-HELP GROUP
 It is also known as the bank-linkage model
 It commonly involves two institutions i.e NGO
promoter and banks
 NGOs and other government programs facilitate the
formation of SHGs
 A good example in Tanzania is CRDB bank-linkage
model
 The members maintain their accounts with the SHGs
 Normally bank does not have direct dealing with
individual members

SELF-HELP GROUP
 The group make decision on regular savings
that is managed by group
 Members can borrow individually from the
group at terms decided by the group
 SHG opens bank account and deposit funds
in order to qualify for bank loans
 Well kept records by the SHG and other
qualifications enable the group to access
bank loans for on-lending to its members

SELF-HELP GROUP
 Benefits of using groups in MFIs
 Economies of scale – more clients served by a fixed
operating investment
 Economies of scope – ability to deliver multiple
services through group mechanism
 Reduce information asymmetry
 Improve loan collection
 Costs and risks transferred to clients
 Reduce moral hazard risks through group monitoring
 Assistance with repayments

SELF-HELP GROUP
 Disadvantages of using groups
 Group formation and maintenance can be
costly, time-consuming
 Costs and risk are transferred to clients
 Reduced learning of individual client’s credit
histories

SELF-HELP GROUP
 SHGs
Bank:
Group savings
External loans
SHG:
IInternal account
Savings
Internal loans
NGOs:
Group formation
Training

SELF-HELP GROUP
 Internal loans are small and mostly used for
consumption purposes
 Income generation mainly begins once the
group access bank loans
 Loans are used for wide range of economic
activities

MICROFINANCE TIERS IN TANZANIA
 The National microfinance act 2018, recognizes four tiers

of microfinance in Tanzania
 Tier 1: Deposit taking microfinance service
institutions
 Tier 2: non-deposit taking microfinance service
providers such as individual money lenders
 Tier 3 : SACCOS
 Tier 4: Community microfinance groups

ROLES OF MICROFINANCE
INSTITUTION
 They provide the rural population with access
to savings within the local area and with a
certain cushion against economic fluctuations
 They encourage cooperation and community
feeling, as evidenced by Informal and small-
scale lending arrangements that have long
existed in many parts of the world e.g. Upatu
(Tanzania), Upato (Zambia), Esusu, Susu,
Osusu ( West Africa), Njagi (Cameroon).

INSTITUTION
 Microfinance institutions play a
complementary role to the banking system by
extending credit to borrowers whom banks
view as too costly or too risky to reach.
 Microfinance institutions can play an
important role in development in
circumstances where other sectors of the
economy are repressed.

INSTITUTION
 Microfinance institutions attempt to compete
with moneylenders by offering credit to a
broader range of households on more
favorable terms.
Lacking collateral, and often living far from
banks, poor households often turn to expensive
informal moneylenders when confronted with
urgent credit needs. Repayment of these
moneylenders may leave some families worse
off.

INSTITUTION
 The groups formed provide joint collateral
and serve as instruments for spreading
valuable information that is useful for
economic and social progress.
 Microfinance facilitate the transfer of
resources from savers to investors like other
financial intermediaries, but in a different
scale

PRINCIPLES OF MICROFINANCE
 The poor need a variety of financial

services, not just loans
 Poor people need a wide range of financial
services that are convenient, flexible, and
reasonably priced.
 Depending on their circumstances, poor
people need not only credit, but also savings,
cash transfers, and insurance.

 Microfinance is a powerful instrument

against poverty
 Access to sustainable financial services
enables the poor to increase incomes, build
assets, and reduce their vulnerability to
external shocks. Microfinance allows poor
households to move from everyday survival
to planning for the future, investing in better
nutrition, improved living conditions, and
children’s health and education.
 Microfinance means building financial

systems that serve the poor
 Poor people constitute the vast majority of the
population in most developing countries. Yet, an

overwhelming number of the poor continue to
lack access to basic financial services.

 In many countries, microfinance continues to

be seen as a marginal sector and primarily a
development concern for donors,
governments, and socially-responsible
investors.
 In order to achieve its full potential of
reaching a large number of the poor,
microfinance should become an integral part
of the financial sector.

 Financial sustainability is necessary to

reach significant numbers of poor people.
 Most poor people are not able to access
financial services because of the lack of
strong retail financial intermediaries. Building
financially sustainable institutions is not an
end in itself.

 It is the only way to reach significant scale

and impact far beyond what donor agencies
can fund. Sustainability is the ability of a
microfinance provider to cover all of its costs.
It allows the continued operation of the
microfinance provider and the ongoing
provision of financial services to the poor.

 Achieving financial sustainability

means reducing transaction costs,
offering better products and services
that meet client needs, and finding
new ways to reach the unbaked poor.

 Microfinance is about building permanent

local financial institutions
 Dependence on funding from donors and
governments—including government-
financed development banks—will gradually
diminish as local financial institutions and
private capital markets mature.

 Micro-credit is not always the answer

 Micro-credit is not appropriate for everyone or
every situation.
 The destitute and hungry have no income or
means of repayment need other forms of
support before they can make use of loans.

 In many cases, small grants, infrastructure

improvements, employment and training
programs, and other non-financial services
may be more appropriate tools for poverty
alleviation.
 Wherever possible, such non-financial
services should be coupled with building
savings.

THANK YOU FOR LISTENING
 End

2 Microfinance

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MICRO FINANCE AND TRADITIONAL

June 18, 2024 Dr Macha J 1

June 18, 2024 Dr Macha J 2

Commercial Banks Fifteen billion shillings

2 Limited Scope Banks

June 18, 2024 Dr Macha J 3

 Microfinance regulations 2019,

June 18, 2024 Dr Macha J 5

To some MFIs interest rate

June 18, 2024 Dr Macha J 7

June 18, 2024 Dr Macha J 8

June 18, 2024 Dr Macha J 9

Micro-finance has other forms of collateral

June 18, 2024 Dr Macha J 10

June 18, 2024 Dr Macha J 11

June 18, 2024 Dr Macha J 14

 MFIs imposes compulsory savings so as to:

June 18, 2024 Dr Macha J 16

 Formal sector institutions

 Informal sector institutions

June 18, 2024 Dr Macha J 17

 These are institutions, which are subjected

June 18, 2024 Dr Macha J 18

June 18, 2024 Dr Macha J 19

 Informal financial intermediaries operate

–keeping standards and are not reflected in

 It is an unorganized ‘nuisance’ sector whose

 Savings and loan associations

June 18, 2024 Dr Macha J 22

 Why the poor or low income individuals use

June 18, 2024 Dr Macha J 24

June 18, 2024 Dr Macha J 25

June 18, 2024 Dr Macha J 26

June 18, 2024 Dr Macha J 27

June 18, 2024 Dr Macha J 28

June 18, 2024 Dr Macha J 29

June 18, 2024 Dr Macha J 30

 The National microfinance act 2018, recognizes four tiers

June 18, 2024 Dr Macha J 31

June 18, 2024 Dr Macha J 32

June 18, 2024 Dr Macha J 33

June 18, 2024 Dr Macha J 34

June 18, 2024 Dr Macha J 35

 The poor need a variety of financial

June 18, 2024 Dr Macha J 36

 Microfinance is a powerful instrument

 Microfinance means building financial

population in most developing countries. Yet, an

 In many countries, microfinance continues to

June 18, 2024 Dr Macha J 39

 Financial sustainability is necessary to

June 18, 2024 Dr Macha J 40

 It is the only way to reach significant scale

June 18, 2024 Dr Macha J 41

 Achieving financial sustainability

June 18, 2024 Dr Macha J 42

 Microfinance is about building permanent

June 18, 2024 Dr Macha J 43