How to Succeed in Microfinance

How to Succeed in Microfinance

By Mayowa Oduola, Acumen+ London Chapter volunteer

The phenomenal success of many microfinance initiatives throughout developing nations has sparked interest in the microfinance movement across the globe. However the success of some microfinance enterprises also brings to light the failure of others. What separates successful microfinance start-ups from unsuccessful ones? By comparing successful microfinance business models we have found 5 Critical Success Factors that stand out.

1) Putting your Clients First

Microfinance clients are typically groups of women living in rural poverty, self-employed in the informal economy in occupations such as head of households, artisans or small-scale farmers. These characteristics combined usually deny them access to loans from commercial banks and other financial institutions. Research has shown that many failures of microfinance enterprises occurred due to the lack of financial and managerial training of clients, before loans were allocated. Another reason provided for why clients default on loan repayments is a sudden health crisis within a family. “If you have to choose whether to buy medicine for your child or to pay back an instalment, a mother will always choose the former.” Valentino Piana (2008). Thus putting the welfare of your clients first, and building towards a stable investment environment is in the best interests of investors. This will help to create healthy, long standing relationships between the two. Providing assistance activities such as financial training, health and value chain support can help achieve this.

2) Keeping Costs Low and Increasing Efficiency

In microfinance the key to having lower interest rates is increasing efficiency. Operating costs make up the largest part of interest rates, due to most microfinance enterprises being labour intensive. Operating costs have been estimated to account for up to 60% of interest rates, however in countries with relatively low operation costs such as Ethiopia, interest rates tend to be much lower. Thus increasing efficiency in the long-run will reduce the risk of loan default, by reducing the interest rate charged. If microfinance enterprises want to achieve long-term success, then it is crucial that they keep both operating and administrative costs low, and that they implement increasing efficiency as an integral business practice.

3) Allowing Clients to be Substantially Involved in Management

The beauty of microfinance lies in the opportunity to create mutually beneficial exchange between investors and clients. Microfinance investors who are looking for new investment opportunities can partner with clients, who have specialist knowledge about a foreign market. Who can better understand a market, than the self-employed individuals who have traded in it, who understand the cultural habits of their society and thus understand the consumption habits of their local people? In this way, microfinance can effectively bridge the gap between the lack of finances for small-scale entrepreneurs, and the lack of foreign market expertise for investors. The key success factor here lies in finding the right balance between providing business support for clients, and allowing them to manage a business model that they are likely to have expertise in.

4) Choosing Borrower Group Participants Wisely

As previously mentioned the majority of microfinance loans are provided to borrower groups typically made of women. One of the key features of microfinance loans is ‘joint liability.’ This refers to the group lending structure where loans are granted to an entire group, and each member of this group is jointly responsible for the loan repayment. In this way joint liability increases the financial stability of microfinance loans, however it also leads to the possibility of one group member defaulting on their loan part, and leaving the rest of the group responsible for their debt. This is why it remains crucially important to encourage borrower groups to search for credible and trustworthy group participants, to the best of their ability. It is also very important to teach the importance of having a good credit rating, and to warn clients of the dangers of ‘ghost lending’- where a member borrows funds on behalf of somebody else.

5) Creating Harmony between Investors and Borrower groups

Finally in order to succeed in microfinance, there needs to be harmony not only between borrower groups, but also between investors and microfinance clients. Sharing experience, knowledge and financial expertise can have a significant impact on the success of a microfinance enterprise. Here transparency between all members is important, and investors should work closely alongside clients to monitor how loans are used, and how profits are allocated. These steps are necessary in building long term relationships between clients and borrower groups and they reduce the risk of loan default. Above all however it is important for both investors and clients to work together, to develop a long-term perspective on their business model and business objectives. Only microfinance enterprises that build sustainable business models will ultimately succeed.

One of the most interesting and challenging things about microfinance is the definition of success. How do you maintain the balance between profitability and social impact? It is clear that there are constant trade-offs and incredibly tough decisions to be made between the two. As the debates surrounding the effectiveness of microfinance continue, it is clear that the issues of sustainability, adaptability and profitability will need to be incorporated in all future decision making.