Sunday, September 13, 2009

Microfinance - Providing capital and services in new ways

Microfinance, (social lending, microcredit, or peer-to-peer (P2P) lending), is a means of providing small loans and other financial services such as savings, training, networking, and peer support, at reasonable or no interest rate often to low-income entrepreneurs. It often involves direct links between individual providers of capital and individual recipients of capital and can be many-to-one or one-to-many credit structures. Borrowers often provide financial and personal information about themselves and lenders decide whether or not to contribute to their loan request.

The concept of giving small loans to entrepreneurs, that has gain popularity through online micro-lending platforms, and the awarding of Dr. Muhammad Yunus and Grameen Bank the Nobel Peace Prize in 2006, has existed for a very long time in areas such as Ghana (susus), India (chit funds), Indonesia (arisan) and Mexico (tandas).

Access to Microfinance
There is an estimated $300 billion demand for microfinance services with a current supply of $15-25 billion in loans. In 2007 more than 100 million of the world's poorest families received a micro loan. As can be shown in the figure from State of the Microcredit Summit Campaign Report 2009, approximately 90% of the poorest clients are in Asia, home to approximately 63,5% of the world's people living on less than US$1 a day.

Provided by various types of organizations
Microfinance organizations (MFIs) vary in sophistication, philosophy, scope of services and scale, with the majority being small and unsophisticated. Organizations can either be constituted as not-for-profit organizations such as Kiva or for-profit organizations such as MYC4. However, a common denominator is the will to reduce poverty in the world.

From the estimated 10000 organizations that are involved with microfinance, less than 2% are believed to be commercially viable, whereas the majority are dependent on government and private grants.

Revenue Models
Revenue models can be based on a combination of joining fees, commission fees for both borrowers and lenders for every loan, or commission on monthly repayments. Additional revenues can come from donations, sponsoring partners and advertisers. Many microcredit models use a system of peer support and pressure where borrowers are responsible for each other's success to ensure that every member of their group is able to pay back the loans.

Social and Environmental benefits
Microfinance activities can also be combined with training and advice to the entrepreneurs to help increase the business' chances of success. In areas where health education improves the life of family members and business clients, healthcare information can also be provided together with the financial services.

Cost Structure
There are several different business models around microfinance from local lenders to aggregators of lenders, and international companies providing interest-bearing financial securities issued by microfinance providers. Similar to normal banking activities there are costs to managing risk, lending and collecting payments, setting up infrastructure and hosting platforms, keeping track of accounts and profiles, issuing loan contracts, etc. MFIs also need to develop strong brand identities and trust to attract micro-lenders.

Transparency - a major Challenge
Today many would argue that Microfinance is not yet a high volume low margin business, but a high margin business given the lack of competition and transparency in many MFIs. There is a major challenge for MFIs to be transparent on all parts of the business model as lenders want to know: Who are they working with? What activities are being done by the MFI? What is it offering entrepreneurs in terms of services and cost of capital? How are the services delivered? What are the social performance of the loans and its results?

Creating valuable assets
Increasingly companies and organizations in the developed world see developing countries as unexplored high volume low margin markets for their products and services. Microfinance organizations that have established brands and high quality relationships with local entrepreneurs in remote markets have an interesting possibility to leverage these relationships as a platform for developing and distributing various products and services.

Leveraging microfinance infrastructure
An interesting example is Grameen Shakti in Bangladesh, that leverages the brand and infrastructure of Grameen Bank's nationwide microfinance program. It was created in 1996 to reach rural people with clean and affordable energy in a country where 80% of the people still do not have access to electricity. The revenue model is often based on several shopkeepers sharing one system, with the electricity enabling new business opportunities. By 2002 Grameen Shakti reached break-even and by 2008 it had installed more than 180000 solar home systems, installing more than 8000 new ones each month.

"Business must be for profit but profit must also be for purpose" Mads Kjaer, co-founder of MYC4

"No one ever ended poverty by going bankrupt" John Hatch, founder of FINCA

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