Sanjay Sinha recently wrote about the evolution of the microfinance sector in a detailed article, How to calm the charging bull – An agenda for CGAP in the decade of the “teenies”, which was published by Microfinance Focus. While you will enjoy reading his post, which also suggests policy changes for the CGAP in the face of repayment crises, here are some excerpts that pertain to the shift in the philosophy of CGAP’s message to MFIs over the years.

Microfinance has evolved from the slow moving tortoise of the 1990s to the nimble hare of the early “noughties” (2000-05) and, since then, into an overcharged bull growing at 70-100% per annum in some markets.

Moving From Slow to Rapid Growth

During the 1990s, when “grant-funded NGO microfinance providers regarded the welfare of the poor as their primary responsibility, the common concern was that microfinance service providers were too tolerant of delinquency by clients”. Defaulters were often forgiven or their loans were restructured, which harmed credit discipline and sometimes pushed non-performing loans up to 20% of the total portfolio.

Secondly, NGOs were unable to transparently and accurately determine the amount of subsidies and grants they had received owing to inconsistent accounting practices (grants could be recorded as income as well as owner’s equity). Therefore, an NGO’s sustainability level and capital structure were often unknown.

Thirdly, NGOs attempted to simultaneously perform the roles of ‘benevolent givers’ (through social programs) and “hard-nosed collectors of zero delinquency loans” (through microfinance programs), which confused clients and workers, who often let “the benevolent orientation of the NGO prevail over the strict disciplinarian role of the lender”.

CGAP then adopted the following principles:

Zero tolerance of delinquency (despite this, a 2-3% default rate existed in the most efficient MFIs)

No restructuring or refinancing of client loans (even though the highly successful Grameen Bank practiced widespread restructuring)

Clear awareness of sustainability performance (through measurement of Operational Self Sufficiency and Financial Self Sufficiency Ratios)

Microfinance services provided by separate, exclusively focused teams with no other responsibilities (specialized microfinance institutes emerged and operated under strict regulations).

The widespread acceptance of these codes “accelerated (growth) to a healthy 30-50%”, which was supported by “MFI networks/associations, training organizations and specialized microfinance rating agencies”, as well as private and public investors.

From Rapid Growth to Sustainable Levels

However, as markets saturated and competition intensified in the face of the global financial crisis, several problems emerged:

• Insufficient managerial controls to match high growth rate in products, clients, markets and employees (read more about the dangers of reckless growth and about a possible solution through information systems)
• Aggressive credit collection practices to minimize delinquency rates
• Limited outreach to the poor, and poverty stricken
• Products that do not match client needs
• Fewer funds available from international donors (read funding options)
• Deteriorating work conditions for employees
• MFI mission changing in favour of investors (example, Bank Compartamos)
• Multiple borrowing and over-indebtedness, leading to repayment crises in certain markets, such as Bolivia, Pakistan, Nicaragua, Morocco.

“Worldwide, growth of the typical MFI was of the order of 25% per year during this period (slowing to 15% with some drying up of on-lending funds during 2008)”.