The NEW Microfinance: Taking a Financial Market System Perspective Part I – Supply

The microfinance industry has grown exponentially in the past 20 years. Why then does nearly half the world remain unbanked? Many of us involved with microfinance thought with the commercialization of microcredit and the addition of savings services and microinsurance, financial inclusion for the poor would be achieved. However, while microfinance seems to have become a household word, we certainly cannot begin to say we have reached financial inclusion.

The New Microfinance Handbook suggests that in order to increase financial inclusion, financial markets need to work better for the poor, not just microfinance institutions. To make markets work better, stakeholders must take a market systems approach and consider both the supply of and demand for financial services (the “core” of the system where transactions take place) as well as the rules (both formal rules such as policies and regulations, and informal rules such as cultural norms) and supporting functions (infrastructure, funding, information, etc.) that contribute to making financial markets work.

In the NEW Microfinance: Taking a Financial Market System Perspective – Parts I and II, we examine the core of the market—that is the demand and supply—and acknowledge the importance of genuinely understanding the market system and the roles and functions of different actors within the core.

Outreach of Financial Services

There is no doubt that access to financial services play an important role in economic development and improving the quality of life for those who use financial services. As the seminal book Portfolios of the Poor points out, the poor may live on two dollars a day or less but they rarely receive two dollars each and every day. So they are constantly juggling trying to manage varied and erratic cash flows. Financial services that help smooth incomes and manage risk are highly valued. However services that support management of cash flows often require frequent transactions and often in tiny amounts. Thus the ability to save and borrow right in the community is fundamental—which is why so many financial services are provided in the informal sector, and may partially explain why the outreach of MFIs in many countries remains below ten percent.

Why is Access/Outreach not Greater?

Providing financial services to poorer populations, particularly to those living in rural areas, remains a challenging goal for the microfinance industry. Rural environments are typically characterized by poor communications infrastructure, low population density, low levels of literacy, relatively low profitability and/or high risk of many economic activities, and economies dominated by agriculture (meaning there is significant covariance risk and farmers tend to need financial services all at the same time). Poor urban areas suffer from many of the same problems albeit with a somewhat more diversified economic base. As a result, it has so far proved difficult for NGO microfinance institutions (MFIs), let alone commercial financial institutions to serve poor people with a variety of services that meet their needs.

In order to increase outreach we need to better understand what financial services poor people need and use and how they access these services. I suggest that most of our work and focus over the last 20 years has been too much about how institutions can be sustainable, how they can increase outreach, and how they can serve poorer people. Often the discussion ends up focused on product development, and often based on assumptions rather than real evidence. For the most part we talk about what institutions can do for clients rather than really focusing on client behaviour and needs. The difference may be subtle but by focusing primarily on institutions as the solution, we may miss identifying constraints (and opportunities) in other areas of the market system. While this is certainly changing and there is a lot of discussion about being ‘client-centric’, I do think we need to go a bit further and in the first instance, put aside the institutional agenda and focus on understanding better how the poor currently use financial services—what types of services, from what types of providers, and how—and let that have a much greater influence in how we think about increasing financial inclusion.

We need to take a more holistic view acknowledging the multitude of financial service providers that serve poorer populations. This requires looking beyond the formal sector and understanding the informal sector better. Broadening our thinking from a focus on moving poor people into the formal system to also understanding and thinking about how community-based providers can be improved and facilitated, I think would be of great benefit. As the table below shows, there is a large variety of providers that can meet the needs of low-income populations.

Fig6-range_fin_svc_pvdrs

Source: The New Microfinance Handbook: A Financial Market System Perspective

I think the research through financial diaries brilliantly documented in Portfolio’s of the Poor and other studies goes a long way to understanding who the poor are and their behaviour—specifically the number and variety of financial services and providers they use to manage very complicated lives.

Altogether, acknowledging that people living in poverty have a number of financial service needs which are met by a multitude of financial service providers—both formal and informal—will go a long way to better understanding how to increase financial inclusion.

Joanna Ledgerwood is the author and editor of The New Microfinance Handbook, published by the World Bank on February 18, which addresses the need for increased financial inclusion by examining the financial market system, beginning with client needs.

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