Critical Dialogue on Microfinance

Chicago GSB Management Conference 2005


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The conference’s keynote address was given by Marilou Uy, Director, Financial Sector Operations and Policy Department, The World Bank. Excerpts of her address follow.

The conference today is entitled, "Expanding the Frontier onMicrofinance," and I would like to associate it broadly with building financial systems that work for all members of society. This may resonate better with economists and business people, but I will explain why there is a closing of the gap between specialized microfinance and financial systems and formal financial systems.

Before doing so, let me put in perspective an important goal that many policymakers in developing countries and international financial institutions like the World Bank pursue. This year, with only 10 years to go, we will meet at the United Nations to review the achievements of the 2015 Millennium Development Goals, adopted by the International Financial Community to improve the lives of the poor.

The overall goal of cutting poverty by half will be met, thanks to very strong performances from India and China, but many other countries will still be left behind. To meet these goals, it is necessary to learn how to effectively scale up efforts that promote development and eradicate poverty. Last year, we also met in Shanghai with policymakers, development practitioners, and academics to share experiences and learn from each other regarding initiatives that might have the possibility of being scaled up to reach the very poor. A good number of case studies on microfinance were presented, including experiences in the scaling up of microfinance models that were integrated into countries' financial systems. Such financial systems that work for the poor can be very powerful in fighting poverty.

Indeed, the World Bank's empirical research, which looks at financial sector development, poverty reduction, and growth, shows a very strong association between growth and financial sector development, and growth and poverty reduction. There is a causation going from financial sector development to growth, financial sector development to poverty reduction, and financial sector development to better income distribution.

So, if one sees empirical research and the compelling evidence behind the role of finance and poverty reduction, then one can conclude that building inclusive, well-developed financial systems that work for the majority of the population is critical to complementing two pillars of a development strategy that creates a favorable business climate and invests in people, as an inclusive financial system gives people opportunities to capture the benefits of this investment climate and investments in people.

One area that has clearly contributed to a more inclusive financial sector has been the development and growth of microfinance over the past 30 years. When I first got involved with microfinance ten years ago, microcredit was viewed by many as a niche. It is now well-accepted that a diverse array of financial services can be used by poor people to smooth their consumption, manage their risks, build assets, and improve their lives. It's also well accepted that financial institutions can tailor financial services to fit the needs of the poor.

Now these financial services are what we would call "microfinance"-the intermediation of deposits and various types of credits, and the many related activities that lower the risk of financial intermediation. It is also well accepted that serving poor people with financial services can be profitable.

Indeed, microfinance today looks very different from its very early days. We are rapidly moving from a narrow perspective in which microfinance was seen as special loans to help the poor build small businesses, to a broader vision of creating financial systems that actually work for the poor. While microfinance has started to reach a greater proportion of the poor in a few countries, there is still a very long way to go.

The important question that is being posed in this conference is: What role can business play in transforming the microfinance industry to help it achieve greater scale, growth, and impact?

Let me give you an overview of what's been happening in the microfinance landscape over the past few years. Real integration of microfinance with mainstream financial systems is occurring at a fast pace in a number of markets. In some places, the reach of microfinance providers is poised for a large increase, not just in terms of branches, but also in virtual ways.

This trend is occurring in three ways. Banks and other institutions with significant branch infrastructure are going down market, driven by competition and cost saving technologies that allow them to deliver smaller credit at lower costs. We have observed these trends in many countries including India, South Africa, Brazil, and Egypt. On the other side are the microfinance institutions that are scaling up and building branch networks. This trend is particularly evident in South Asia, Latin America, and some countries in Africa.

Many microfinance institutions also are transforming into banks. With more commercial funding from these institutions, there is greater imperative for professional standards, such as financial reporting and rating, and a trend toward the professionalization of the industry.

A third trend is the very strong partnerships that are being built between socially oriented microfinance institutions and banks. There are financial and nonfinancial organizations with large infrastructures, and these partnerships are being forged to leverage each other's comparative advantages.

Over half of the microfinance institutions in East Asia and Central Asia, according to a survey by the Consultative Group to Assist the Poor (CGAP), had contractual relations with a bank. CGAP has counted 280 such partnerships worldwide. It seems that the commercial financial sector and the microfinance sector are both building out and meeting somewhere in the middle. Indeed, this integration seems to be a path towards inclusive financial systems, which we view as a very important part of financial sector strategies of countries and businesses.

How can one support the fast and continuous development of inclusive financial systems? First, policy and institutional foundations are critical. By this we mean that governments can ensure that regulatory policies foster the development of the sector. One example is the regulation of microfinance institutions that transform into banks. Regulators do have to learn the business of microfinance in order to regulate them properly.

Microfinance will thrive if interest rate policies are not restrictive, and if governments themselves do not engage in highly subsidized credit programs. Financial infrastructure provides the foundation for good financial systems via policy and institutional foundations. For example, the availability of credit information can help people with no physical assets to develop reputational collateral that can facilitate access to finance.

The World Bank and IFC are very strongly promoting and working with countries to put in place credit reporting systems, including credit bureaus. Yet, another example is good financial reporting of microfinance institutions-a trend which CGAP is also promoting.

Second, we need to strengthen financial institutions serving the poor far beyond the classic microfinance institutions, including savings banks, cooperatives, and rural banks. Many of these institutions offer distribution systems that can reach underserved areas of society, particularly in the rural parts of a country. There is a need to continuously seek new and effective ways to deliver financial services to the underserved, and here, technology can play a role, as can alliances with those that have more basic infrastructure, such as post offices and rural credit cooperatives. For example, Correspondent Banking in Brazil has taken root where banks have a partnership with post offices, which could be the basis for expansion in rural areas.

One other factor that could push inclusive financial systems is competition. Competition enhances experimentation, which has characterized the industry in the past few decades. Competition also can push banks to go down market and accept the idea that taking informed risks by lending to entrepreneurs and households rather than only to governments and big corporations can be rewarding and a way to build goodwill.

Competition can come from many places. It can come from the development of securities markets that can then push banks to pursue customers other than big corporations. It also can come from the scaling up of microfinance institutions that achieve sustainability and become part of a more dynamic financial system. The World Bank Group, CGAP, and many of our partners are actively supporting promising institutions to achieve this goal. The overall vision draws on many advantages of policies that facilitate access to finance. Many of these are familiar to you: competition, technology, dissemination of practices, to name a few, which leaves room for a multiplicity of institutions and national models. Before closing, let me address the significance of holding a microfinance conference at a business school. What is the role that MBA students like you can play both now and in the future in bringing together business objectives with social economic development objectives?

We are pleased to see schools of the caliber of the University of Chicago Graduate School of Business, the Harris School of Public Policy, and the Kellogg School of Management taking such a keen interest in microfinance. Such interest is critical to encouraging research and development of new ideas and structures.

It also means we look to students like you as future leaders, potential policymakers, and entrepreneurs who can make a difference in pushing the frontiers of inclusive finance, meshing what one would call hard business decisions with social goals such as reaching poor households and entrepreneurs.

Business school students have tremendous knowledge and opportunity to innovate, be entrepreneurs, be social entrepreneurs, lend your expertise to figuring out how financial services can function more efficiently, or how systems can function more efficiently and reach a broader spectrumof society.Microfinance does not only need money; in fact, in many countries where we work, money is not an issue. What is needed is research, ideas, technology, good policies and institutional foundations, good laws, and champions perhaps like you.

In closing, let me reiterate our commitment and support toward building inclusive financial systems with diverse products that fit the needs of the poor. There is still a long way to go in making finance reach the great majority, and we do have a large role to play to reach the billions of people who can still benefit from financial services to smooth their consumption, manage their assets, build assets, manage their risks, and ultimately, improve their lives. Thank you very much.

53rd Annual Management Conference
53rd Annual Management Conference
The University of Chicago Graduate School of Business · Critical Dialogue - November 2005