1. Microfinance Industry failing people living in poverty?
Since the 1990s, there has been a great deal of hope and enthusiasm that the microfinance industry would help to bring millions out of poverty through provision of microcredit. However, the once hailed panacea for poverty alleviation has been under strict scrutiny for failing to achieve the promise that many hoped would bring. Critics suggest that MFIs don’t appear to be different from village moneylenders (loan sharks) due to the exorbitant interest rates they charge. Recent research by Banerjee and company in Hyderabad India reinforced the skeptics’ idea that microfinance interventions have failed to prove impact on health, education or women empowerment[i]. This finding is consistent with four other similar research reports[ii].
The emphasis on micro-credit and the quest for financial sustainability has been a stumbling block for reaching the rural poor in sufficient numbers. Services have been skewed to urban areas and away from the rural poor due to high transaction costs and low loan values with interest too low to be profitable. Moreover, the majority of rural poor are not the entrepreneurial base that they are made out to be. Loans are largely not investments, but rather used to smooth consumption. The lack of basic money management skills and viable rural enterprise options mean that there are generally not the skills or resources available to generate enough income to pay off debt. In this situation, loan-focused interventions could even lead to excessive debt burden and worsen the overall situation of the rural poor.
2. Traditional group savings and credit associations
In Africa and elsewhere, there is a long-standing tradition of community members forming groups to help each other in times of difficulties. One of such self-help initiative is the Rotating Savings and Credit Association (ROSCA). ROSCAs are community-based financial initiatives in which self-selected members of a group regularly (usually every week) contribute an equal amount of savings toward a common fund. The collected fund is disbursed to an individual member who is queued to get the contribution. The disbursement rotates among members until every member has received the pooled fund.
The advantages of the ROSCAs system are: transparency; low transaction cost; and security of funds (since it is disbursed immediately). The main disadvantage is the fact that money is allocated on a rotating basis means that funds are not tied to need or opportunity, but rather on one’s position in the rotation. Moreover, leaders could misappropriate the fund and membership tends to wane after members have received their disbursement, thereby leaving fewer and fewer people contributing. This makes for a shrinking pot.
3. Advantages of group based savings and loans programs
One example of a group-based financial initiative is the Accumulated Savings and Credit Association (ASCA). In the ASCA model, self-selected community members form a group to contribute an equal amount to a common fund. Once the fund has accumulated to an agreed-upon sum or duration, the group starts lending the savings fund to its members.
The advantage of the ASCA system is that it gives a good framework for members to contribute a set amount of money into savings that could otherwise be spent on impulse purchases or lent as an unguaranteed loan to members of the collectivist society (relatives, friends, or neighbors). It also creates a kind of autonomous village bank, capable of saving enough to satisfy a limited but vital set of members’ borrowing and insurance needs.
The ASCA system has a lot of advantages over the formal MFI or traditional ROSCA when adapted to fit the special context of community members. According to Hugh Allen, success is high with the group-based savings and loan approach as long as the methodology is transparent and simple[iii].
- Groups are self-managed with simplicity and transparency of operations; meeting the basic needs of clients for simple and accessible savings and credit needs.
- Groups don’t rely on donors funding for loan, providing flexibility on loan sizes and terms.
- Very low group management costs, high efficiency and almost perfect financial intermediation.
- Groups’ run their business effectively, providing extraordinary and always positive real rates of interest on clients’ savings.
- Programs locally staffed and managed with minimal training and orientation.
- Flexible adaptation of the model and easy and rapid scaling to other areas.
- Groups provide a forum for training of community members with money management skills, health or other community development issues.
3.2 Main challenges
- Savings and loan transactions require record keeping with a little bit of sophistication, which doesn’t fit to the groups’ leadership skill-set.
- The fact that money is changing hands from savers to group leadership means that there is a risk of mismanagement. The occurrence of which could completely destroys group members’ confidence.
- Continuity of groups’ operation is at risk after promoters leave the area.
- Group’s access to credit is limited by their ability to save. This forces a “closed economy” of sorts. If a major shock were to hit, then savings would largely be withdrawn and groups would have little capital to borrow.
- There may be competition among potential borrowers as they queue to borrow a limited supply of savings.
4. Why Nuru International supports group based rural financial services?
Nuru International believes that group-based savings and loan programs are the best alternatives for poor, rural areas due to their ability to reach a massive scale; their cost effectiveness; and their high-level of efficiency. Members take loans in amounts that are closely aligned with their actual needs and opportunities. They learn basic money management skills from training programs organized by promoters or from each other. Members also earn returns on their savings contributions. Savings deposited today can give members access to a much-needed financial safety net against minor illnesses, smooth consumption, or pay for their children’s education expenses. Savings can also be used to start up or expand microbusinesses. Last but not least, group members can build a sense of community: serving as a forum to discuss community issues; mobilizing knowledge and resources; and building social capital among group members.
[i] The miracle of microfinance? Evidence from a randomized evaluation by Abhijit Banerjee; Esther Duflo; Rachel Glennerster; and Cynthia Kinnan, 2013.
[ii] See for example Crepon et al. (2011); Angelucci et al. (2012); Attanasio et al. (2011); and Augsburg et al. (2012) cited in Baneriee et al (2013).
[iii] CARE International’s VSL Program in Africa: Microfinance for the Rural Poor that Works, by Allen Huge, 2002.