Sustainable Banking With The Poor

Building sustainable financial services systems for poor men and women is of critical interest from three perspectives: First, from the point of view of financial sector development, people who have not been integrated into the formal financial sector because of low incomes, gender, ethnic identity or remote location often represent a large and potentially profitable market for institutions that can develop ways to reduce the costs and risks of serving them. Second, from the standpoint of enterprise formation and growth, the availability of stable sources of funding and deposit services contributes to successful start up and operations of micro and small enterprises. Third, from the perspective of poverty reduction, access to reliable, monetized savings facilities can help the poor smooth consumption over periods of cyclical or unexpected crises, thus greatly improving their economic security. Once some degree of economic security is attained, access to credit can help them move out of poverty by improving the productivity of their enterprises or creating new sources of livelihood.

All three perspectives are reflected with diverse emphasis and approaches in the recent literature. We review here the main themes, highlighting the areas of consensus as well as those of controversy, and stressing those in which further work seems necessary.

Access and Sustainability

There is growing consensus on the premise that, once the start-up costs have been incurred, financial services can be sold to the working poor without recurrent subsidies under conditions that allow the financial intermediary to become self-sustainable. What conditions favor, or deter, the attainment of self-sustainability and effective outreach is the central question guiding the work of many researchers, policymakers and practitioners in the field. A key question in this regard is how to move from a one-way flow of grant funds to project beneficiaries (finance as charity) to reciprocal contracts between institutions and clients who buy financial services and must agree to pay for them (finance as business).

In addition to the challenge of clearly distinguishing business from welfare, there may be instances where barriers created by remoteness, poor infrastructure, a stagnant economy, illiteracy or social factors like caste and gender render self-sustainability unattainable in a reasonable time frame. The role and rationale of subsidies, recurrent or time-constrained, emerge as central questions demanding response.

Financial and Social Intermediation

Another subject of current debate is that overcoming the many barriers that have prevented large potentially productive segments of the population from access to formal financial institutions may require more than conventional financial intermediation. Integrating under-served groups into the formal financial markets may entail some measure of up-front investment to develop the human resources (confidence, knowledge, skills and information) among the clients, and often to build local structures that help them link with financial institutions. It also involves investing in changing the skill mix and operating procedures of the financial institution seeking to expand its outreach. This process of developing new markets among the working poor is thought of as social intermediation.

Social intermediation is distinct from the provision of social welfare services in that social intermediation enables beneficiaries to become clients able to enter into a contract involving reciprocal obligations. The level, nature and time horizon of the investment required for social intermediation varies with the barriers facing a given target group. It is also likely to depend on the level of responsibility in financial intermediation that the client group is required or willing to acquire.

Defining the Target Group: The Poor and the Poorest

Recognizing the heterogeneity of "the poor" is of crucial importance to properly identify "best practice" design features for poverty-alleviation programs. Programs and institutions that may be judged successful in helping households rapidly climb above the poverty line and increase their incomes from successive loans, may be considered failures if the standards of evaluation are set in terms of raising and protecting the incomes of the poorest.

The implications of adequately defining the target clientele are not only a matter of using the correct standards of performance for programs and institutions, but obviously affect the selection of appropriate instruments and mechanisms in poverty alleviation and income enhancement efforts. While there are now many examples of programs and institutions serving the working poor with financial services in a self-sustainable manner, the very poor, the destitute and the disabled ought to be beneficiaries of transfer programs that do not entail creating an additional liability for the recipient. A first question that emerges from this target-group definition is where to draw the line between the viable and the non-viable. One answer is the "ability to repay" — that is, a practical response based on the ability of clients to reveal their viability by meeting their contractual obligations. The target-group definition becomes, for the institution, a matter of anticipating or predicting that ability, and adjusting or diversifying its portfolio as more is learned about the client population in the course of its operations.

Recent findings suggest that successful institutions contributing to poverty reduction are particularly effective in improving the status of "middle and upper income" poor. Furthermore, their impact on the client’s income seems to be directly related to the level of income, which would reinforce the tendency for these programs to concentrate in that segment of the poor in order to preserve their viability. A related consequence is that refinements and improvements in finance-for-the-poor technologies remain focused on the middle and upper segment of "the poor," leaving "the poorest" behind.

The recognition of the heterogeneity of the poor should lead to a further phase of institutional innovation and experimentation to possibly deepen the downward reach of financial services. On the other hand, there is still a large unsatisfied demand for financial services among the bankable poor which could be met through mainstreaming the known successful approaches. There is much to be accomplished in properly understanding and then replicating, adapting and adjusting models of sustainable provision of financial services to poor clients.

Overcoming and Reforming the Policy Environment

A range of macro-policy issues including depoliticization, ownership and governance, in addition to regulatory issues, should be addressed before workable and sustainable approaches can be developed to improve the access of the rural poor to financial services. Indeed, whether there are absolute pre-conditions for successful financial intermediation with the poor may still be a matter of debate. There is little doubt, however, that a conducive policy and regulatory environment will greatly facilitate the emergence and improve the effectiveness of programs and institutions servicing low-income clients.

The policy reforms, especially interest-rate liberalization, that preceded the emergence of the BRI Unit Desas in Indonesia have been well documented. Likewise, for microfinance institutions entering the regulated financial sector, there seems to be a set of necessary conditions encompassing interest-rate liberalization, the elimination of barriers to entry, and the establishment of adequate supervisory and regulatory agencies and rules for these specialized institutions.

The remaining questions on this subject refer to the degree to which the policy and regulatory environment impinge upon the performance of microfinance institutions not necessarily operating as regulated financial institutions. The ability to function in a negative environment may come at considerable costs for clients, institutions and sponsors. Circumventing regulations, substituting for non-existent markets, institutions and contracts involve substantial transaction costs, and often result in rationing out sectors of the client population which the institutions and programs want to serve. Consensus seems to exist on the need for careful identification and analysis of the environmental features which would have the greatest impact on the outreach and sustainability of institutions and programs working with the poor.

The Challenges of Institution Building

The emphasis on sustainability has brought in its train a much greater attention to the importance of institution building. It is well recognized that it is not sufficient just to reach the poor with one or two "doses" of credit, to provide them with an asset that can generate sufficient income to move them out of poverty. This was the logic of India’s massive Integrated Rural Development Program (IRDP), widely recognized as having greatly weakened India’s commercial banking system by mixing charity (and political patronage) with business, undermining client repayment discipline and completely neglecting the institution building dimension. As has been documented, after more than 15 years of IRDP, the poor in India still have no reliable access to formal financial services that meet their demands (for savings and consumption-smoothing loans rather than just loans for productive assets). They still face high transaction costs and rationed access and most of the commercial banks are no closer to understanding the poor as customers or having appropriate products and processes available than they were when IRDP began — though with collection performance for IRDP loans at between 20 and 30 percent, many of them are much closer to insolvency.

As an institutional form, group-based approaches have received much attention in the literature and the variety of these approaches reveals that practitioners have moved beyond simply "replicating" a few well-known models to experiment with a range of institutional arrangements involving groups. Almost all of these arrangements include a major role for some type of an NGO as "social intermediary" to identify existing affinity groups or to help communities form their own self selected groups. However, there are important differences in the way NGOs see this role, and these differences appear to have significant effects on group financial — and social — performance.

What is the source of lending capital for NGOs? Does it come from group member deposits (at least in a substantial proportion)? From a bank (on commercial terms)? From a donor? From the government? The answer to this question helps to define the role of the NGO vis-ˆ-vis the group — and also appears to have a significant impact on the financial performance of the group. When the donor and government sources predominate, the primary locus of risk in the intermediation system is with the donors or the government. Despite the ideology of group liability, in most cases it is either the donor agency or the government which loses money in cases of default. Hence, the NGO which plays the role of social (but not financial) intermediary for these funds tends to feel accountable to either the donors or the government. The NGOs reporting system in such cases tends to report on what the funders care about (the smiling faces of poor women borrowers) rather than what a genuine financial intermediary would need to know (liquidity, solvency, profitability and efficiency) to maintain and improve its performance.

In contrast, when the primary source of lending capital comes from either member savings or formal financial institutions (at market rates) or some mix of the two, then the locus of risk is proportionately shared by the group members and/or the banks. The NGO in this case may play the role of financial intermediary between the banks and the groups or it may simply facilitate the linkage and allow the groups to function as the intermediary between their members and the banks. But in all of these cases, the role of the NGO and its sense of accountability is likely to be very different and much more oriented to the "bottom line".

Further Readings

Carlos Cuevas. 1996. "Sustainable Banking for the Poor." Journal of International Development, Vol. 8, March-April.

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