we need government

A productive and gracious society requires government action of many kinds. Some governments are predatory, and corruption is often rampant, but the task is not to eliminate the government; rather, it is to make it strong, honest, and efficient. We need to recognize this and accept it as an urgent task.

Henry J. BrutonProfessor Emeritus

Williams College

March 2008 • Volume 9 Number 1

The quarterly newsletter of the Focal Point for Microfinance at ADB aims to provide information on microfinance. Articles in the newsletter, however, do not necessarily reflect official ADB views. Articles may be reprinted with proper acknowledgement of the source. Please address any inquiries, comments, and suggestions concerning the newsletter or its content to the Focal Point for Microfinance; Office of Director General; East Asia Department. Asian Development Bank, 6 ADB Avenue, Mandaluyong City, 1550 Metro Manila, Philippines. Tel +63 2 632 6931 • Fax +63 2 636 2337 • E-mail: nfernando@adb.org. In this publication, $ refers to US dollar.

Making Microfinance Work for the Extreme Poor: Evidence and Experiences from Bangladesh 1

Development of Microfinance Organizations in Uzbekistan 8 Selected Publications on Microfinance 11

IN THIS ISSUE

Bangladesh is often cited as a crucible of microfinance possibilities. With regular innovations in products, processes, and their continuous assessments, microfinance in Bangladesh has managed to reach millions of poor and vulnerable non-poor households. All the major microfinance institutions (MFIs) are geared toward achieving social outcomes, while maintaining financial performance. In keeping the balance between the two bottom lines, a concern of excluding the extreme poor1 in microfinance has emerged. Based on the existing evidence of the extent and the quality of microfinance participation by the extreme poor in Bangladesh, we argue that a mix of specialized packages is required to serve specific sections of the extreme poor.

ParticiPation oF the Poorest in MicroFinanceMicrofinance started to gain prominence as an effective intervention for the poor since the early 1980s. As such, poverty-focused MFIs used “ownership of less

Making Microfinance Work for the Extreme PoorEvidence and Experiences from Bangladesh

by MUnshi sULaiManResearch Officer, Research and Evaluation Division

and

iMran MatinDirector, Research and Evaluation Division

Building Resources Across Communities (BRAC)

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than 50 decimal of land” as the eligibility criteria.2

This targeting criteria ought to be inclusive of the extreme poor, and this was the case in the initial years. Hashemi (1997),3 for instance, found that the extent of mistarget-ing (participants having more than 50 decimal of land) was around 5% in the early 1980s. Since then, microfinance in Bangladesh expanded at re-markable rates, and achieving massive scale in an efficient manner has been the key driv-er of such expansion. Such focus on scale of operations has resulted in broadening the clientele base. In 1991–1992, the proportion of participants having more than 50 decimal of land was between 20% and 30% for Building Re-sources Across Communities (BRAC), Bangladesh Rural Development Board, and Grameen Bank.4 This hap-pened because of both the

placement of the MFIs in better-off areas5 and enrolment of better-off households in existing locations.6

This trend continued throughout 1990s, and by the end of 1997, about 32% of the participants in the areas covered by Palli Karma-Sahayak Foundation’s (PKSF) partner organizations were “non-target” group, i.e. having more than 50 decimal of land.7 Using a separate set of data with only the eligible members, the same study revealed that the non-participants are more likely to be absolutely landless.

Such findings in a number of other studies started to raise the concern of neglecting the poorest of the poor. Moreover, the prominence of land as the principal poverty indicator declined

considerably during the 1990s and many of the non-poor shared the characteristics of owning less than 50 decimal of land.8 For example, 53% of the population owned less than 50 decimal of land in 1991 and the share has increased to 66% in 2000.9 Therefore, one would have expected a greater participation of “eligible” households participating even if they are not poor while the reverse has been observed. For the inaccuracy of land as sole indicator of poverty, we need income/expenditure or another broader set of indicators to explain the depth of outreach. Such estimates reveal that microfinance participation is the lowest among the poorest quintile and the highest among the second poorest quintile.10 Several other studies have also shown similar scenario in poverty outreach by microfinance nongovernment organizations (NGOs).11

Despite lack of concrete evidence on the reasons of this under-representation of the poorest in microfinance, some plausible explanations are often cited. These include self-exclusion of the poorest because of risk aversion and group-exclusion by the moderate poor.12 On part of the product design, the rigidity of weekly repayment in existing microfinance and excessive focus on borrowing force the poorest to self-exclude themselves.13

However, since the late 1990s, there has been renewed focus on reaching the extreme poor through alternative packages, which we will discuss later. As a result, their participation has increased over the years and from a recent survey in 2004, Zeller and Johannsen (2006)14 found that the proportion of microfinance participants in the bottom two income quintiles were 24% and 23%, respectively.

natUre oF ParticiPation oF the extreMe PoorClearly the extent of participation of the poorest in micro-finance has consistently been lower than expected, and this has been changing over the years—relatively high during the formative years, declining sharply during the scaled up years, and then gradually increasing again with specialized focus on the extreme poor.

However, estimating microfinance participation rates of the extreme poor per se conceals the fact that their quality of participation is poorer and more fragile than others. For ex-ample, frequent entry-exit for a particular group and consistent “graduating out” for another group can yield similar levels

Despite lack of concrete evidence on the reasons of this under-representation of the poorest in microfinance, some plausible explanations are often cited. These include self-exclusion of the poorest because of risk aversion and group-exclusion by the moderate poor.

have limited fallback options, they often end up as “clients” if they participate.

Finally, on the part of the extreme poor, there are some psychosocial factors resulting in limited and low-quality microfinance participation. According to Webb et al,21 their participation remain less fruitful since they (a) have low aspirations because of high discount rate for future, (b) lack confidence in skills acquired through trainings, and (c) lacked entrepreneur-ship because of their risk-averse nature. Such institu-tional, personal, and prod-uct-related factors combined together lead to a pattern of microfinance participation of the extreme poor, which is arguably not likely to create a meaningful impact.

how beneFiciaL has MicroFinance been For the Poorest?There have been a number of impact studies to evaluate microfinance programmes. However, most of these evaluations suffer from dif-ferent methodological limi-tations.22 Khandker’s recent estimates,23 based on data collected in 1990s, indicated that microfinance has a posi-tive impact on the income of the poor. However, the estimated gains are much lower than his earlier estimates. Using the same data, Morduch24 found that microfinance does not have any significant effect on income but on vulnerability.

of participation for both groups at any point of time. In fact, participation of the extreme poor in microfinance is marked by lower levels of borrowing, smaller loan sizes, frequent exits and re-entries, and reported difficulties in repayment. Studies focusing on client exit demonstrate that the extreme poor have greater likelihood of dropping out and their average length of participation is much lower,15 findings that are expected given the differentials in the levels of initial endowments between the extreme poor and others. There is a growing body of literature on chronic poverty suggesting that it is structurally different and requires interventions with a more comprehensive set of entry points that microfinance, on its own, does not offer.16

Even when the extreme poor are brought into microfinance through promotional programmes (such as income generation for vulnerable group development [IGVGD] or challenging the frontier of poverty reduction/targeting the ultra poor [CFPR/TUP]),17 they are less likely to take loans and borrow smaller amounts when they do. A microfinance group with the extreme poor is likely to have a borrower-member ratio between 50% to 60% and an average loan size of 2,400 Bangladesh taka.18 This lower level of borrowing—smaller loan size with poten-tially lower loan increment—signifies that any microfinance programme for the extreme poor will take much longer to reach financial sustainability and may require long-term cross subsidization or direct subsidies.

Different institutional factors, such as rigidity in repayment or considering the extreme poor as risky clients, hindering them from participating, are also responsible for this nature of participation for those who do. Rahman19 identified that lack of flexibility in repayment as the major cause of client dropout and delinquency among the extreme poor. Moreover, sometimes the economic opportunities also prevent them to get into the long-term, rigid contract. For example, about one-fifth of the dropout clients in Rahman’s study discontinued their credit participation to take the advantage of seasonal migration, an economic activity that mainstream microfinance products are unable to accommodate. Idiosyncratic shock factors that provoke exit include illness of major income earners, family problems and/or disapproval, migration, death, or cash flow problems within the business.20 Since the extreme poor are more vulnerable to these shocks and

A microfinance group with the extreme poor is likely to have a borrower-member ratio between 50%– 60% and an average loan size of 2,400 taka.

This lower level of borrowing—smaller loan size with potentially lower loan increment—signifies that any microfinance programme for the extreme poor will take much longer to reach financial sustainability...

FINANCE for the poor

Fewer studies have looked at the differences in impact across participants’ poverty groups. However, there are some evidence that the im-pact of loans on a borrower’s income is associated with the initial income status.25 The middle or upper income groups are most likely to de-rive the direct benefits, quite unlike the extreme poor. Simi-larly, Zaman26 shows that the positive impact of borrowing on the poverty and vulnerabil-ity, which is observed for the moderate poor, is insignificant for the extreme poor. Most of the constraints associated with the extent and nature of participation are linked to the expected level of impact. However, two additional fac-tors are worth explaining to elaborate on the limited im-pact of microfinance on the extreme poor.

Firstly, there is evidence that clients with existing micro-enterprises or employment (so called “the economically active”) are the only ones that can benefit from micro-finance.27 However, many of

the extreme poor do not have an enterprise of their own and mostly rely on day labor. Therefore, a good portion of the ex-treme poor who are borrowing are doing that to meet different livelihood needs and emergencies, such as house repairing, cope with shocks, etc. Not using the funds directly for income purposes coupled with the rigidity in microfinance can result indebtedness.

Secondly, impact on income becomes more prominent in the third cycle of borrowing,28 which suggests that one has to be able to keep borrowing and investing to realize meaningful benefits from their participation. However, the extreme poor are often forced to exit prematurely because of factors beyond their control. They will require some effective intermediary protective mechanisms in case of difficulty in repayment.

Existing impact evaluations, especially those that focus on the wider impacts and spillovers, find that microfinance leads to upward pressure on agricultural wage rate as borrowers diver-sify their livelihoods from agricultural to non-farm activities.29

This effect has been argued to benefit the poorest who rely on agricultural labor. However, there may be other constraints that affect the ability of extreme poor households to sell labor, such as high morbidity, adverse demographic structure, extremely poor nutritional status, etc. Moreover, the extent to which such diversification will affect agricultural wage rates would also de-pend on the growth in agricultural productivity. Experts suggest that the initial gains to be made in the context of Bangladesh have already been reaped and that the further gains will be harder. It is also likely that there is a spatial dimension to the concentration of the extreme poor who are caught in chronic poverty, living in marginal and environmentally fragile areas of the country.

how can MicroFinance heLP the Poorest?It is now widely recognized that microfinance alone is largely inadequate for the poorest. However, discussions on what can be done to address this demonstrates two broad trends: one is centered around addressing the demand-side constraints of the poorest before introducing microfinance, while the other has been a focus on supply-side constraints of microfinance that make it difficult for the poorest to participate meaningfully. Within this, the thrust of the discussion has been on innovations of the financial product (such as introducing flexibility, more risk responsiveness of products, etc.), rather than the process (such as staff engagement quality, internal group cohesion, etc.) which may be equally important to ensure effective mi-crofinance participation of the poorest. Working on the process domain becomes critical as most scaled-up microfinance very quickly does not usually pay much attention to this aspect once the initial microfinance culture is built.

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Impact on income becomes more prominent in the third cycle of borrowing, which suggests that one has to be able to keep borrowing and investing to realize meaningful benefits from their participation. However, the extreme poor are often forced to exit prematurely because of factors beyond their control.

Over the last 5 years, a number of programs have been initi-ated to make microfinance more relevant and effective for the poorest.30 These specialized packages fall into three broad categories:

redesigning the core product (which includes reducing interest rate, adding flexibility in repayment period and method, etc.); microfinance plus (putting additional services with the core product to make it attractive for the poorest); and sequencing of interventions (adding microfinance with other targeted interventions).

The very poor need a lot more flexibility in the product than most MFIs are currently providing. However, this may not be enough. For instance, despite the flexibility, SafeSave, an in-novative urban microfinance provider, does no better in reach-ing the extreme poor.31 Similarly, MFIs are often criticized for charging high interest rates and often the policy suggestion is to charge lower interest for the extreme poor. In fact, recent research shows that borrowers are responsive to interest rate change and the elasticity of borrowing for interest rate change is higher among the relatively poor.32 However, the practical difficulty with differential interest rates is the mechanism of targeting and tracking who gets the actual benefits of the subsidies.33

In the “microfinance plus” approach, the additional service needs to be something that the poorest have reasons to value. Skill development training had been a regular component in this package, but this is not adequate since the activities can gener-ate very little productivity gain.34 On the other hand, morbidity and ill health have been regularly identified as the major cause of lower productivity of the extreme poor. Therefore, health services is often suggested to be included in “microfinance plus” packages.35

While designing financial services for the extreme poor, we need to be aware of their heterogeneity.36 The “microfinance plus” approach can serve a great segment of the extreme poor, but is not going to be effective for all of them, especially those in the bottom decile. Therefore, we need to combine the differ-ent approaches targeting different groups. Spatial differences will also need to be considered. We present BRAC’s strategies for addressing extreme poverty as a case of targeted approaches

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crafting a Graduation Pathway for the Ultra PoorBRAC's Approach37

Drawing from its learning of the first phase of the challenging the frontier of poverty reduction (CFPR) programme, BRAC redesigned the second phase to broadly categorize the extreme poor into two groups: the bottom 10% (the ultra poor), and those above. BRAC also spatially distinguishes between the most food-insecure areas and those that are just above.

For the ultra poor in both areas, BRAC uses an elaborate package consisting of asset transfer, cash stipend, intensive training and mentoring, health subsidy, and interventions for social inclusion. However, the package for the ultra poor living in slightly better-off areas have lower support intensity. For instance, the average asset value for the ultra poor living in the poorest areas ranges from 6,000 Bangladesh taka (Tk) to Tk2,000, whereas the maximum is Tk6,000 for the ultra poor living in slightly better-off areas. Similar differences exist for cash stipend and intensity of staff mentoring.38 After 2 years, the ultra poor are formed into groups and given the opportunity to participate in BRAC’s regular microfinance programme.39

For the extreme poor who are slightly better off than the ultra poor, and this is the group that tend to participate in microfinance, albeit with mixed gains, BRAC will provide a support package consisting of enterprise training, subsistence allowance, health subsidy, more intensive staff support than regular microfinance, and appropriately designed microfinance to suit their relevant enterprise cash flow. Spatial adjustments are made to the package such that it is relatively more intensive for those living in the poorest areas of the country.

The average cost inclusive of management support for the asset-based, more expansive package is about $300 per member over 2 years, while it is about $100 for the non-asset-based package for the slightly better-off extreme poor members.

Evaluation studies based on panel data found that members of this program managed to sustainably improve their economic and nutritional status significantly by the end of the 2-year cycle.40 The participants were able to increase their income by over 30% because of this participation. Quality and quantity of food improved along with increase in asset and income.41 Participants had higher access to formal and informal credit, and they were more confident in terms of better and faster recovery from crises. Even though about half of the participants did not borrow from the microfinance program, the improvements in livelihood outcomes were evident.

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for different groups of extreme poor in Bangladesh (see box on previous page).

concLUsion

Inclusion of the poorest in microfinance is often discussed in terms of trade offs in social and financial performance.42 Of course, reaching the poorest with microfinance is more costly for their lower borrowing ratio, greater risk factors, smaller loan size, and lower increments that they can usefully absorb. However, this is too narrow a perspective, which is unlikely to generate the kind of innovations we need to get the extreme poor out of chronic poverty. Microfinance can be an important link in the mix of interventions that is needed to achieve this, but we need to be more imaginative with microfinance as well as go beyond it. Effective packaging and sequencing of interven-tions that are likely to make microfinance work for the poorest will possibly have to address both demand- and supply-side constraints, including the process of delivery. n

enDnotes

By extreme poor, we generally refer to the population belonging to the bottom quintile ranked by income or expenditure.

Ownership of less than 50 decimal (half an acre) of land had been one of the key indicators of poverty for the rural population in Bangladesh.

Hashemi, S. 1997. Those Left Behind: A Note on Targeting the Hardcore Poor, in Who Needs Credit? Poverty and Finance in Bangladesh. (Eds.) Geoffrey D. Wood and Iffath A. Sharif. Dhaka: The University Press Limited.

Morduch, J. 1998. Does Microcredit Really Help the Poor? New Evidence from Flagship Programs in Bangladesh. Unpublished mimeo. Department of Economics and HIID, Harvard University and Hoover Institution, Stanford University.

Sharma, M. and Zeller, M. 2000. Considerations in the Placement and Outreach of Microfinance Organizations: The Case of ASA, BRAC and Proshika in Bangladesh. Policy Brief No. 4. Rural Financial Policies for Food Security of the Poor. IFPRI, Washington DC.

Matin, I. 1998. Mis-targeting by the Grameen Bank: A Possible Explanation. IDS Bulletin 29(4): 51–58.

Mahmud, S. 2000. The Gender Dimensions of Programme Participation: Who Joins a Microcredit Programme and Why?, The Bangladesh Development Studies 26 (2 and 3): 79–101.

Toufique, K. A. and Turton, C. 2002. Hands Not Land: An Overview of How Livelihoods is Changing in Rural Bangladesh. BIDS, Dhaka and DFID, UK.

Bangladesh Bureau of Statistics, 2003. Report of the Household Income and Expenditure Survey, 2000. Dhaka: Bangladesh Bureau of Statistics.

Zaman, H. 2005. The Economics and Governance of Non Government Organizations in Bangladesh. Consultation Draft. Washington, DC: World Bank.

Rahman, A. and Razzaque, A. 2000. On Reaching the Hardcore Poor: Some Evidence on Social Exclusion in NGO Programmes. The Bangladesh Development Studies 26 (1): 1–35.

Hashemi, S. and Rosenberg, R. 2006. Graduating the Poorest into Microfinance: Linking Safety Nets and Financial Services. Focus Note No. 34. Washington, DC: CGAP.

Rutherford, S. 2000. Raising the Curtain on the “Microfinancial Service Era”. Small Enterprise Development. 11(1):13–25.

Zeller, M. and Johannsen, J. 2006. Is There a Difference in Poverty Outreach by the Type of Microfinance Institution? The Case of Peru and Bangladesh. Conference Paper for Access to Finance: Building Inclusive Financial Systems. Washington, DC: World Bank and Brookings Institution, 30–31 May 2006. downloaded from http://info.worldbank.org/etools/docs/library/232675/ZellerJohannsen_paper.doc on February 18, 2007.

Matin, I. 2005. The Very Poor Who Participate in Microfinance Institutions and Those Who Never Did: A Comparative Analysis. Small Enterprise Development 16(30):51–57.

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2.

3.

4.

5.

6.

7.

8.

9.

10.

11.

12.

13.

14.

15.

See www.chronicpoverty.org for extensive literature on chronic poverty.

IGVGD is a food transfer program and CFPR/TUP is an asset transfer program. Both have a graduation strategy involving microfinance.

Sulaiman, M. et. al. 2006. Microfinance Engagement of the “Graduated” TUP Members. CFPR/TUP Working Paper No. 9. RED, BRAC and Aga Khan Foundation Canada. Current exchange rate is approximately $1 = Taka 68.50.

Rahman, I. R. 2000. Poverty Alleviation and Empowerment Through Microfinance: Two Decades of Experience in Bangladesh. Research Monograph 20. Dhaka: Bangladesh Institute of Development Studies.

Hasan, G.M., and N. Shahid. 1995. A Note on Reasons of Dropout from Matlab Village Organizations. Dhaka: BRAC-ICDDRB Joint Research Project Report.

Webb, P. et. al. 2002. Does Microcredit Meet the Need of All Poor Women? Constraints to Participation Among Destitute Women in Bangladesh. Discussion Paper No. 3. Food Policy and Applied Nutrition Program. TUFTS Nutrition. TUFTS University, Boston MA.

For review of earlier evaluations, see Chen. M. 1992. Impact of Grameen Bank’s Credit Operations on its Members: Past and Future Research. Mimeo. Cambridge: Harvard University; and Sebstad J. and G. Chen. 1996. Overview of Studies on the Impact of Microenterprise Credit. Mimeo. AIMS Project. Washington, DC: USAID.

Khandker, S. R. 2003. Micro-finance and Poverty: Evidence Using Panel Data from Bangladesh. Policy Research Working Paper 2945. Development Research Group, Washington, DC: World Bank.

Morduch, J. 1998. Does Microcredit Really Help the Poor? New Evidence from Flagship Programs in Bangladesh. Unpublished mimeo. Department of Economics and HIID, Harvard University and Hoover Institution, Stanford University.

Hulme, David and Paul Mosley. 1997. Finance for the Poor or Poorest? Financial Innovation, Poverty and Vulnerability, in Who Needs Credit? Poverty and Finance in Bangladesh. (Eds.) Geoffrey D. Wood & Iffath A. Sharif. Dhaka: The University Press Ltd.

Zaman, H. 2000. Assessing the Poverty and Vulnerability Impact of Micro-credit in Bangladesh: A Case Study of BRAC. Policy Research Working Paper No. 2145. Washington, DC: World Bank.

See, Robinson, M. 2001. The Microfinance Revolution: Sustainable Finance for the Poor. Washington, DC: World Bank; Hulme and Mosely. 1997 (Ibid); and Zaman 2000 (Ibid).

Montgomery et. al. 1996. Credit for the Poor in Bangladesh: The BRAC Rural Development Programme and the Government Thana Resource Development and Employment Programme. in Hulme, D. and Mosely, P. Finance against Poverty. Vols. 1 and 2, London: Routledge.

Khandker S.R, et. al. 1995. Sustainability of a Government Targeted Credit Programme: Evidence from Bangladesh. World Bank Discussion Papers No. 316. Washington, DC: World Bank.

BRAC’s CFPR, now in its second phase; Chars Livelihood Programme (CLP); and PKSF’s Financial Services for the Poorest (FSP), now a component of PKSF’s Promoting Financial Services for Poverty

16.

17.

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20.

21.

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Reduction (PROSPER) programme; are some examples. The concern with reaching the poorest is also evident in many other nonfinancial programmes, such as BRAC’s Water, Sanitation, and Hygiene Programme, which has the potential to bring about significant positive changes to the nonfood environment. This has been argued to be a main reason for the high infection rates leading to high disease burden and consequently malnutrition and child death. This is significant as earlier studies argue that exclusion of the extreme poor from microfinance also leads to their exclusion from other services provided by NGOs, see Rahman A. and A. Razzaque, 2000 (Ibid).

Cortijo, M. J. A. 2005. An Assessment of Depth of Poverty Outreach of SafeSave, Bangladesh. Downloaded from www.safesave.org/MJ%20Summary.pdf on 03 November, 2007. More information on the operations of SafeSave are available from www.safesave.org

Dehejia, R., et. al. 2005. Do Interest Rates Matter? Credit Demand in Dhaka Slums. Unpublished (work in progress). Downloaded from www.nber.org/%7Erdehejia/papers/dehejia_montgomery_morduch.pdf on 15 September, 2007.

Most MFIs charge lower interest rates as a part of specialized products to help clients recover from natural disasters. What is targeted is an event and a generalized need rather than specific clients.

Barua, P. and Sulaiman, M. 2007. Is the BDP Ultra Poor Approach Working? Survey of Some Key Issues. CFPR/TUP Working Paper No. 16. Dhaka: Research and Evaluation Division (RED), BRAC, and Aga Khan Foundation, Canada.

Morduch, J. and Haley, B. 2002. Analysis of the Effect of Microfinance on Poverty Reduction. NYU Wagner Working Paper No. 1014. New York University, NY.

Matin, I. 2005. Ibid.

For more details on BRAC’s CFPR programme, visit www.brac.net/research.

BRAC is considering experimentation; instead of giving away livestock as an asset, they will provide appropriate support mechanisms to the ultra poor living in slightly better-off areas so that they can access livestock share rearing markets. Similar market access and linkage approach may also be considered for other sectors.

Some degree of flexibility is provided. For instance, the requirement of 5% of the loan amount as security is not applicable for the ultra poor microfinance members; the starting loan size can be lower than regular microfinance; and they have more flexibility in savings deposit and withdrawal.

Rabbani, M., et. al. 2006. Impact Assessment of CFPR/TUP: A Descriptive Analysis Based on 2002–2005 Panel Data. CFPR/TUP Working Paper No. 12. RED, BRAC, and Aga Khan Foundation, Canada.

Haseen, F. and Sulaiman, M. 2007. How Sustainable is the Gain in Food Consumption of the CFPR/TUP Beneficiaries?. CFPR/TUP Working Paper No. 18. Dhaka: RED, BRAC, and Aga Khan Foundation, Canada.

Fernando, Nimal A. 2004. Microfinance Outreach to the Poorest: A Realistic Objective? Finance for the Poor. Vol 5(1): 1–5. ADB, Manila.

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creDit Unions: Fastest GrowinG seGMentAll types of microfinance providers report significant growth in a vastly underserved market, with credit unions being the fastest growing segment. In contrast to the experience in many other countries in Central Asia and beyond, the legal foundation for credit unions in Uzbekistan was established before major efforts were devoted to actually establishing credit unions. Beginning in 1998, substantial technical assistance from the Asian Development Bank (ADB) and the World Council of Credit Unions, financed by the United States Agency for International Development, supported the development of a sound legal and regulatory framework and capacity building for individual credit unions. A credit union law was enacted in mid-2002. The first credit unions were licensed in September 2002. From the outset, the focus on development support for credit unions was on training of credit union staff and members, the establishment of systems, and some limited grant support for equipment rather then providing liquidity support in the form of credit lines.

By end-2005, 20 credit unions had been established and per-formed well. Since then, the number of credit unions increased to 32 at end-2006 and 49 at end-2007. The number of members increased from 48,000 at end-2006 to 64,000 at end-2007. In parallel, the outstanding credit portfolio of credit unions has risen sharply. It exceeded the equivalent of $10 million in late 2006 and has more then doubled since then. The average loan size of credit unions was $1,400 at end-2006. Credit unions had about 9,000 loans outstanding at that juncture. Credit union activities are concentrated in urban centers, although about 10% of loans are extended for agricultural purposes.

Despite recent growth, the number and size of credit unions is still very small for a country like Uzbekistan with a population of 27 million. In smaller countries in the same region, such as Georgia or the Kyrgyz Republic, for instance, hundreds of credit unions were established within a few years.1 However, the prospects for sustainability appear better in Uzbekistan for a number of reasons.

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introDUctionThe major providers of microfinance in Uzbekistan are com-mercial banks, credit unions and nongovernment organizations (NGOs) involved in microfinance. There is also a specialized state-owned microfinance bank and a number of Government-financed programs targeted at small borrowers. Credit unions and especially microfinance NGOs have greater outreach but smaller asset sizes than commercial banks, indicating stratifica-tion by size in the microfinance market. Pawnshops have only recently begun operation and are not yet significant providers of microfinance.

Development of Microfinance Organizations in Uzbekistan

by JUrGen conraDSenior Economist, Governance and Finance Division

Central and West Asia Department, Asian Development Bank

tabLe 1: Main ProViDers oF MicroFinance in UZbeKistan, END-SEPTEMBER 2006

Number of Sums $ equivalent borrowers (million) (million)b

Banks's micro-creditc portfolio 16,200a 46,600 37.3Credit unions 8,901 13,059 10.4NGO microfinance organizations 20,482 4,107 3.3 Total 45,583 63,766 51.0a As of end-2004.b $1=1250 sums.c This includes the specialized state owned Microfinancebank, whose credit portfolio at end-2006 was, however, negligible.NGO = nongovernment organization.Sources: Central Bank of Uzbekistan, Credit Unions Association of Uzbekistan,

Microfinance Association of Uzbekistan.

The majority of credit unions in Uzbekistan, however, appear to be more truly cooperative, for instance, attracting hundreds of participants to annual general meetings. The self-financing nature of Uzbekistan credit unions has generally ensured that members take a keen interest in credit union performance.

Unlike credit unions in other countries, Uzbekistan's credit unions are wholly funded by shares and deposits of their mem-bers. Member deposits alone accounted for 72% of total assets at end-2007.2 Furthermore, in addition to having established the regulatory framework and supervisory capacity in advance of the formation of credit unions, the concept of cooperative ownership appears more strongly rooted in Uzbek credit unions. Some of these credit unions are, like their counterparts in other countries, cooperative in name only, i.e. under the control of one or a few individuals. The majority of credit unions in Uzbekistan, however, appear to be more truly cooperative, for instance, attracting hundreds of participants to annual general meetings. The self-financing nature of Uzbekistan credit unions has generally ensured that members take a keen interest in credit union performance. A relatively large size of credit union average deposits indicates that more sophisticated people are also attracted to credit union membership, providing a pool of individuals capable of understanding and exercising coopera-tive ownership responsibilities.

This contrasts favorably with most other countries in the region, where external finance, provided to “kick-start” sector develop-ment, has frequently undermined the principle of cooperative ownership of credit unions from the outset. Further, in most other countries of the region credit unions were established and promoted before establishing a sound legal and regulatory framework, which has made it difficult in practice to establish and enforce a sound legal and regulatory framework.

tabLe 2: creDit Unions in seLecteD cis coUntries, END-2005

Market penetration Assets Members as $ equivalent Number Members % of population (million)

Georgia 56 5,710 0.06 1.3 Kazakhstan 136 n.a. n.a. 256.4 Kyrgyz Republic 320 28,972 0.56 15.8Moldova 504 96,299 2.84 18.6Russia 213 277,776 0.19 141.1Ukraine 746 1,297,000 2.76 409.3Uzbekistana 32 47,876 0.18 10.4a As of end-September 2006.CIS = Commonwealth of Independent States, n.a. = not applicable. Sources: World Council of Credit Unions, Credit Union Association of Uzbekistan, National Bank of the Kyrgyz Republic,Kazakhstan Agency of Financial Supervision, International Monetary Fund.

DeVeLoPMent oF MicroFinance nGos Less FaVorabLe so Far

The development of micro-finance NGOs looks less favorable in Uzbekistan. The first such organizations were established in Uzbekistan in 1998 assistance under the United National Develop-ment Program. Subsequent support from other external funding agencies led to the establishment of additional microfinance organizations, peaking at 14 in 2005. How-ever, soon after, a number of microfinance NGOs were closed for a variety of rea-sons: generally challenging business conditions, loss of support from their external sponsor, employee fraud and loan losses, and an uncertain legal environment. Four microfinance orga-nizations had to be closed in conjunction with the enactment of a microfinance law in August 2006 since they did not meet the newly established legal and regulatory requirements. How-ever, since end-2006, the number of microfinance NGOs has

FINANCE for the poor

The approach of Microcreditbank contrasts sharply with that of the credit unions and most NGO microfinance organizations, which attract funding at market rates, are free to set their interest rates, and make lending decisions at their discretion.

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increased again (from 9 to 12) and the Government expects further rapid growth in the subsector.3

At end-2006, total outstand-ing loans of microfinance NGOs amounted to just over $3 million equivalent. The sector was highly concen-trated—the largest microfi-nance organization accounted for 35% of total outstanding loans, the largest four ac-counted for 87% of total out-standing loans.4 To compare, the four largest credit unions accounted for just 35% of the credit unions' total outstand-ing loans.

Collectively, microfinance NGOs had a much smaller average loan size (about $110 equivalent) than either banks or credit unions at end-2006.

The small average loan size was in part due to funding con-straints, and in part due to targeting very small and start-up businesses. Until November 2006, microfinance NGOs oper-ated under a legal framework that limited funding to develop-ment partner grants and their own resources. Some existing microfinance organizations have achieved sustainability, with income sufficient to finance ongoing activities, but most are still dependent on donor support. Lending rates of most mi-crofinance NGOs (and credit unions) in Uzbekistan are in the range of 60%–80% per annum.

coMMerciaL banKs PLay siGniFicant roLe in MicroFinance

About 1%–2% of the loan portfolio of the Uzbek banking system can be classified as small and microfinance. These loans are mainly provided by state-owned or state-controlled banks, whose large market share and branch network has made

them logical vehicles for the delivery of on-lending programs to support small and micro businesses. The funding for these programs comes mainly from a fund for preferential lending into which state-owned banks must allocate 25% of their profits, non-budget government funds, and credit lines of external fund-ing agencies. Foreign credit lines extended through the banks totaled approximately $13.8 million at end-2005. This was little more than one-third of the banks’ microcredit portfolio. Loans provided under state sponsored schemes are significantly below market rates.

sPeciaLiZeD MicroFinance banK estabLisheD by GoVernMent

In 2006, the Uzbek Government established Microcreditbank. This state-owned institution provides credit to business start ups, small enterprises, socially vulnerable families, and female entrepreneurs. Interest rates are highly negative in real terms. Microcreditbank’s start-up loans, for instance, have a nominal interest rate of 5% per year. The official inflation rate for 2006 was 7.6%. Independent surveys put the inflation rate at close to 40%.

Funding for Microcreditbank is provided by the Government under targeted programs. The institution also enjoys substantial tax benefits, such as being exempt from profit tax payments. The approach of Microcreditbank contrasts sharply with that of the credit unions and most NGO microfinance organizations, which attract funding at market rates, are free to set their interest rates, and make lending decisions at their discretion. However, over the past 2 years, Microcreditbank has become the single most important provider of microfinance in Uzbekistan. Microcredit-bank has established 75 branches and 269 other retail outlets. In January–November 2007 alone, the bank disbursed credits in the equivalent of $47 million. Information about loan recovery ratios are not yet available.

oUtLooK

The short history of credit unions in Uzbekistan has been very positive. The sector is still small. However, in light of the slow growth of the Uzbek financial system in general and sustainabil-ity problems of many other financial institutions, credit union development and performance has been impressive. The sector

enDnotes

The population of Georgia and the Kyrgyz Republic is 4 million and 5 million, respectively.

Member deposits play only a negligible role in the funding structure of credit unions in Azerbaijan, Georgia, and the Kyrgyz Republic, for instance.

The Central Bank of Uzbekistan expects the number of microfinance organizations and credit unions to increase to 97 and 62, respectively, by 2010.

These were FVRM-Uzbekistan (catering Fergana valley), FINCA International (Tashkent), NGO Daulet (Karakalpakiya), and the Karakalpakiyan branch of the Business Women’s Association of Uzbekistan.

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seLecteD PUbLications on MicroFinance

booKs

Balkenhol, Bernd (ed.). 2007. Microfinance and Public Policy— Outreach, Performance and Efficiency. Geneva: International Labor Organization.

Barr, Michael, Anjali Kumar, and Robert Litan. 2007. Building Inclusive Financial Systems. Washington, DC: Brookings Institution Press.

Matthaus-Maier, Ingrid and J. D. von Pischke. 2007. Microfinance Investment Funds: Leveraging Private Capital for Economic Growth and Poverty Reduction. Berlin, Germany: Springer Publication.

Yunus, Muhammad and Karl Weber. 2007. Creating a World Without Poverty: Social Business and the Future of Capitalism. New York: Public Affairs.

JoUrnaL articLes

Barnett, Barry J. and Olivier Mahul. 2007. Weather Index Insurance for Agriculture and Rural Areas in Lower-Income Countries. American Journal of Agricultural Economics 89(5): 1241–1247.

Bond, Philip and Ashok S. Rai. 2008. Cosigned vs. Group Loans. Journal of Development Economics 85(1–2): 58–80.

Buerli, Markus, Aden Aw-Hassan, and Colin Poulton. 2007. Microfinance Respecting Islamic Banking Principles in Marginal Dry Areas. Enterprise Development and Microfinance 18(2–3): 189–202.

Chantarat, Sommarat, et. al. 2007. Using Weather Index Insurance to Improve Drought Response for Famine Prevention. American Journal of Agricultural Economics 89(5): 1262–1268.

Chen, Gregory and Kirsten Weiss. 2007. Lessons from South Asian MFIs Moving Up Market. Enterprise Development and Microfinance 18(4): 328–341.

Dalgic, Umud K. 2007. International Expert Organizations and Policy Adoption: The World Bank and Microfinance in the 1990s. Cultural Dynamics 19(1): 5–38.

Gibson, Thomas and Marc de Sousa-Shields. 2007. Crossfire: SME Lending vs. Microfinance. Enterprise Development and Microfinance 18(4): 295–302.

Hollis, Aidan and Arthur Sweetman. 2007. The Role of Local Depositors in Controlling Expenses in Small-Scale Financial Intermediation: An Empirical Analysis. Economica 74(296): 713–735.

of microfinance NGOs has started to recover from a period of weakness in 2006. Both credit unions and microfinance NGOs will likely continue to grow rapidly in the foreseeable future in light of a legal and regulatory framework that is overall accom-modating and a huge unmet demand for credit in Uzbekistan. Conservative estimates put the total number of potential micro-finance borrowers at 800,000. Given this large potential market size, the various government subsidized lending schemes are unlikely to fully crowd out microfinance providers that charge market-determined interest rates. Small and micro-businesses unable to access subsidized credit willingly pay market rates several times higher than the rates charged under Government programs. However, in light of international experience it is realistic to expect that the continued existence of government subsidized lending programs will have adverse effects on the sustainable growth of microfinance in Uzbekistan.

Sector development would certainly further benefit from the removal of remaining weaknesses in the taxation of profits of credit unions and other microfinance institutions and legal and regulatory reforms that would allow microfinance NGOs to intensify financial intermediation by taking deposits. Some of these microfinance NGOs may grow, over time, into com-mercial microfinance banks. Further, the already existing and well performing association of credit unions and the newly established association of microfinance organizations would benefit from (continued) technical assistance aimed at transforming them into an Apex organizations that are able to provide urgency needed treasury services for individual credit unions and microfinance organizations, respectively. n

FINANCE for the poor

Based on the cross-country review of experience, the book provides insights on what is likely to drive rural development in general and inclusive rural development in particular. These drivers include high overall economic growth, effective land reform, rural infrastructure, effective institutions, rural financial services, a dynamic agricultural sector, rural nonfarm enterprises, and subsidies. The review

and discussion of rural development outcomes and drivers also throw light on possible

broad lessons for policy makers interested in inclusive rural development.

A review of country experience suggests that policy makers in most developing economies recognize this importance and have been implementing a host of programs and measures to achieve rural development objectives. While some of these countries have achieved impressive results, others have failed to make a significant dent in the problem of persistent rural underdevelopment.

seLecteD PUbLications on MicroFinance

Jones, Linda. 2007. Conference Report on Rural Finance Research: Moving Results into Policies and Practice, FAO, Rome. Enterprise Development and Microfinance 18(2–3): 255–260.

Kim, Julia C., et. al. 2007. Understanding the Impact of a Microfinance-Based Intervention on Women’s Empowerment and the Reduction of Intimate Partner Violence in South Africa. American Journal of Public Health 97(10): 1794–1802.

Mccarter, Elissa. 2007. Financing the Middle Market in High-Risk and Changing Regulatory Environments. Enterprise Development and Microfinance 18(4): 342–357.

Sengupta, Rajdeep and Craig Aubuchon. 2008. The Microfinance Revolution: An Overview. Review 90(1): 9–30.

Schicks, Jessica. 2007. Developmental Impact and Coexistence of Sustainable and Charitable Microfinance Institutions: Analysing BancoSol and Grameen Bank. European Journal of Development Research 19(4): 551–568.

Skees, Jerry R., Jason Hartell, and Anne G. Murphy. 2007. Using Index-Based Risk Transfer Products to Facilitate Micro Lending in Peru and Vietnam. American Journal of Agricultural Economics 89(5): 1255–1261.

Xavier, Giné, Robert Townsend, and James Vickery. 2007. Statistical Analysis of Rainfall Insurance Payouts in Southern India. American Journal of Agricultural Economics 89(5): 1248–1254.

other PUbLications

Epstein, Keith and Geri Smith. 2007. The Ugly Side of Micro-lending. Business Week 4064: 38–44.

Fernando, Nimal A. 2008. Rural Development Outcomes and Drivers: An Overview and Some Lessons. Manila: ADB.

Ghate, Prabhu, et. al. 2007. Microfinance in India: A State of the Sector Report. New Delhi: Microfinance India.

Ghosh, Suman and Eric Van Tassel. 2007. Microfinance, Subsidies and Dynamic Incentives. Boca Raton: Florida Atlantic University.

Karlan Dean and Nathanael Goldberg. 2007. Impact Evaluation for Microfinance. Doing Impact Evaluation No. 7. Washington, DC: World Bank.

Lieberman, Ira W., et. al. 2007. Microfinance and Capital Markets: The Initial Listing/Public Offering of Four Leading Institutions. Washington, DC: Calmeadow and the Council of Microfinance Equity Funds.

Lyman, Timothy R., Mark Pickens, and David Porteous. 2008. Regulating Transformational Branchless Banking: Mobile Phones and Other Technology to Increase Access to Finance. Focus Note 43. Washington, DC: Consultative Group to Assist the Poor.

Microfinance Information Exchange (MIX). 2007. Cambodia Trends, 2003–2007. Washington, DC : MIX.

Monash Asia Institute, et. al. 2007. Leveraging Remittances with Microfinance: Synthesis Report and Country Studies. Brisbane: Foundation for Development Cooperation.

Natu, Anant Jayant, et. al. 2008. Linking Financial Inclusion with Social Security Schemes. Institute for Financial Management and Research (IFMR) Centre for Micro Finance Working Paper Series No. 22. Chennai, India: IFMR.

Swibel, Matthew. 2008. Microfinance Fever. Forbes Asia 4(1): 66–67.

New Publication from ADBrural Development outcomes and Drivers: an overview and some Lessons