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Clients and Services In this Lesson Poor and low income people use financial services to take advantage of economic opportunities, invest in the future, and protect against economic shocks to their households and enterprises. Typical MFI clients use a variety of sources and mechanisms to manage the cash and other assets of their households and businesses. In order to best help the poor respond to these economic opportunities and shocks, savings and credit services must be permanent, convenient and accessible.

In Depth The importance of financial intermediation Financial services are an important ingredient in any functioning economy. Financial institutions make services possible through intermediation. Financial institutions intermediate between those who have cash surpluses, savers, and those who need cash, borrowers. Without access to financial services, income and the ability to consume and invest become erratic. Access to financial services can smooth erratic periods of income and consumption, and provide safekeeping and returns on excess cash. Financial intermediaries can reduce the transaction costs by matching savers and borrowers within a given market. Financial intermediation facilitates the use of money: for example, a large number of small individual deposits can be transformed into a line of credit for many different businesses. Such intermediation also pools risk, increases liquidity and provides valuable information services. This reduces the costs to borrowers and increases returns to savers. Without financial intermediaries, savers and borrowers would have to seek out uses and sources of funds individually, contributing to higher costs for both.

Financial services, the poor, and risk management Though often thought of as a defined state, poverty is dynamic, not static. An economic shock, such as the loss of household income or fire damage to a workshop, can reduce the vulnerable non-poor to levels well below the poverty line at any time. People use financial services to manage risks in one of two ways. On the one hand, they can protect against risk ahead of time by borrowing to diversify income streams, grow their business, send their children to school or repair their houses. Savings services allow for direct accumulation of capital in a safe place; people can build up their assets to invest in the future or protect against loss. On the other hand, people use financial services to cope with shocks after they have happened. They can draw down on their savings or borrow to smooth over their consumption, rather than sell a productive asset, which decreases their future income generating possibilities. This use of financial services allows people to continue to generate income and build assets.

Usefully large lump sums The business of an average MFI customer often generates revenue over a short cycle, sometimes weekly, even daily. This return may often be of small nominal value. Given the cash constraints on such a business and household, the small sums quickly disappear before they can transform themselves into “usefully large lump sums”, for productive investments in the business, home repairs, educational expenses or other costs requiring lump sums of cash. Life cycle needs, emergencies, and economic opportunities require lump sums. Financial services provide people the opportunity to transform these small cash flows into usefully large ones, whether they are in the form of credit or savings. Stuart Rutherford in his essay The Poor and Their Money 9/13/2007 3:34 PM

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suggests a standard typology of how these small cash flows are transformed into usefully large amounts by “saving up, saving down and saving through”.

Traditional sources of finance A variety of traditional sources of finance exist outside the banking system. Some of these are common personal and business transactions, such as loans from family and friends or the local moneylender or stock purchased on credit from a supplier. More elaborate group schemes exist as well, including funeral and marriage funds, Rotating Savings and Credit Associations (ROSCAs), and Self Help Groups. Group arrangements, such as ROSCAs, vary widely, but retain some common characteristics. Most are ad hoc, informal groups. They may last for a pre-determined period or continue for successive periods. Members contribute a fixed amount each week or month, throughout the period. Members take turns receiving the pot of money according to some order that is either pre-established or done at random. While convenient to their users, ROSCAs and similar services have drawbacks. They are often inflexible or unable to meet the particular financial needs of their users. The amount lent may be too little, or the repayment term too short. Many services also suffer from impermanence and are not reliable for financial service provision into the future.

Savings MFIs typically have two types of savings accounts: voluntary and forced. The former are the more familiar savings services offered in banks, credit unions, and cooperatives and through informal savings mechanisms. These institutions collect either time or demand deposits, provide safekeeping, and yield a return on savings (whether the real value is positive or negative will be discussed in 2.4). Different types of savings instruments serve different financial needs: long-term time deposits may serve for wedding, funeral, or educational expenses. Short-term or demand deposits may be a means to handle excess cash flow from the business cycle. Forced savings, on the other hand, are savings accounts required by an MFI as collateral for a loan. These accounts do not necessarily provide a return on deposit, though some do. Most forced savings must be kept with the institution until the balance of the loan has been paid off. Forced savings accounts constitute transaction costs to the borrower, as the money carries an opportunity cost of other possible productive investments. Such savings must be included in calculating the periodic interest rate, discussed later in lesson 2.4.

Safety in saving Authors such as Stuart Rutherford have long documented the poor’s ability to save, while carefully noting the difficulty they have in finding a safe place to do so. As one of the characteristics of effective savings services presented in this lesson, security of savings ranks among the highest. Finding a safe, convenient place to save without access to institutions that manage this risk can prove difficult. Wads of bank notes rolled up in mattresses, stuffed in jars or kept in a purse are vulnerable to theft, fire or other loss. Moreover, cash demands from household members, neighbors and relatives make cash kept in the house very vulnerable. Such a high premium is placed on the safekeeping of savings that it often outweighs concerns for competitive real returns on deposits, or for any return whatsoever. Many poor people place a premium on guaranteeing the safety of their funds and shielding them from latent claims, often paying dearly for a safe and convenient place to save.

New and developing microfinance product Loans and, to a lesser extent, savings constitute the main products offered by most MFIs today. Yet, these are only a few of the financial services demanded and used by formal financial sector users around the globe, who also look to the financial sector for money transfers, payment service, insurance and other financial products. As the microfinance industry matures, MFIs are developing new products and adapting standard ones from the formal financial sector to meet other needs of their clients. Many MFIs have already experimented with insurance for their clients tied to their outstanding loans. In most cases, clients contribute a small amount to a collective fund that is used to repay a client’s loan if she is incapacitated or if her productive assets are destroyed or stolen. Some MFIs have experimented with insurance plans to protect against loss from fire or theft or to pay for a whole set of life-cycle events, such as the birth or death of a family member. Other new products include payment services, including check cashing, checking accounts, money transfers, and remittances from someone working abroad. Still other new products are wedded to technology, such as smart cards or credit cards. Credits cards, using wide networks such as Visa or MasterCard, allow clients to make purchases charged to their credit card account, anywhere the card is accepted and the infrastructure exists to transact the charge. Smart cards, on the other hand, usually carry information from the client’s line of credit and any savings accounts that can be used to make purchases. 9/13/2007 3:34 PM

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Current Discussions Should an MFI focus on outreach to select segments of the population or reach out to broader markets? How does an MFI exclusively target the poorest? Do targeted programmes reach the poorest? How is depth of outreach measured? Many consider that depth of outreach, or reaching the very poorest segments of the population, should be the primary goal of microfinance. In its relatively brief history, the majority of microfinance operations have depended on donor resources, resources that make up development assistance packages. Proponents of an exclusive focus on the poorest of the poor, argue that development resources to alleviate poverty should be focused on the poorest segments of the population. If operations are not exclusively focused on the poorest members of society, the poorest will not benefit. Others argue that a focus on the poorest of the poor excludes the very poor, the poor and the vulnerable non-poor from financial services. These segments of the population can contribute to local economic development, expanding economic activities and micro-businesses that benefit the poorest. Proponents of broad outreach contend that providing financial services to larger segments of the population, including the poorest, with different products and pricing mechanisms allows an institution to grow, to reach poorer and more isolated clients with a variety of services as well as attract other institutions into the market. To reach the poorest of the poor with financial services, MFIs have developed a variety of targeting mechanisms. These mechanisms range from market-oriented techniques to techniques adopted from social welfare programmes. These latter techniques require considerable intervention on the part of the MFI to ensure that only the poorest members of a community can access services. An example of a directed targeting mechanism is wealth ranking, or measuring assets and income of the client, which allows the MFI to assess a potential client’s poverty before lending or accepting deposits. An example of a market-oriented targeting mechanism is locating branches in poor neighborhoods. Using direct measurements to ascertain the poverty level of potential clients can add to the institution’s operational costs, which are ultimately born by the client if that institution is planning to become sustainable. A “poverty assessment”, similar to an institutional assessment that looks at the progress towards institutional and financial viability, allows an analyst to measure the relative poverty of an MFI’s clients compared to others living in the same area. Measuring average loan size as a percentage of Gross Domestic Product provides a proxy indicator for depth of outreach among an MFI’s current clients. While simple to calculate, this indicator provides little information about a client’s poverty as many MFIs offer pre-determined initial loan amounts and fixed increases for subsequent loans. Microfinance operations that exclusively target the poorest appear to have a greater percentage of poor clients within their client base. Many of these operations may not have undertaken a rigorous analysis of whether those clients are the poorest in a community. More transparency is often called for in this aspect of donor-funded microfinance for those operations that claim to exclusively target the poorest of the poor. It is also apparent that many MFIs that have a broad-based market strategy also reach very poor people with their services.

Recommended Reading Rutherford, Stuart. The Poor and Their Money. Oxford: DFID, 2000, pp. 13-30..

Additional Reading Demand of Clients for microfinance Chen, Martha Alter and E. Dunn. “Household Economic Portfolios”. USAID, AIMS Desk Study, Microenterprise Impact 9/13/2007 3:34 PM

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Project, USAID, June 1996. (*) Robinson, Marguerite S. The Microfinance Revolution: Sustainable Finance for the Poor. Washington, D.C.: World Bank and Open Society Institute, 2001. Rutherford, Stuart. “Raising the Curtain on the ‘Microfinancial Services Era’,” CGAP Focus Note No. 15, May 2000. (*) Rutherford, Stuart. “Savings and the Poor: the Methods, Use and Impact of Savings by the Poor in East Africa,” MicroSave – Africa, May 1999. (*) Von Pischke, J.D. Finance at the Frontier. Debt Capacity and the Role of Credit in the Private Economy. Washington, D.C.: World Bank / Economic Development Institute, 1991, pp. 277-300. Wright, Graham A. N. Microfinance Systems. Designing Quality Financial Services for the Poor, London. New York and Dhaka, 2000.

Traditional sources of finance Rutherford, Stuart. The Poor and Their Money. Oxford: DFID, pp. 60-76. Von Pischke, J.D. Finance at the Frontier. Debt Capacity and the Role of Credit in the Private Economy. Washington, D.C.: World Bank / Economic Development Institute, 1991, pp. 173-187.

New product development Brand, 3. Monica. “New Product Development for Microfinance: Evaluation and Preparation.” Microenterprise Best Practices Technical Notes Numbers 1 and 2, September 1998. (*)

Client poverty assessment Henry, Carla, Sharma Manohar, et al. Assessing the Relative Poverty of Microfinance Clients: A CGAP Operational Tool. Washington, D.C.: CGAP, 2000. (*)

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