Malo e lelei
In my previous blog post about the difference between banks and microfinance institutions (MFIs) I cited ‘people’ as this fundamental difference. MFIs use people to be able to provide financial services for the poor or those who lack access to traditional banking services.
There are a number of reasons why individuals lack access to traditional banking services, which can vary across countries according to geography, banking rules and procedures, and government legislation. It is important to understand these restrictions to understand how MFIs use people to overcome them.
Firstly, physical access to traditional banking services has been a restriction for the poor, particularly in rural areas. Bank branches are often located in wealthy, urban areas and out of reach for the poor. MFIs provide access for the poor by going to them. Group meetings are held regularly (once a week here!) where loan applications, loan payments and savings are collected.
A lack of understanding of the financial products available from banks can deter individuals from wanting to apply for them. It can also make it difficult for these individuals to assess the benefits and costs of obtaining the product. A lack of education may also make it difficult for individuals to complete the loan application process. MFIs overcome this by providing clients with simple products, assisting in the loan application process, and many MFIs (like SPBD) have a dual focus on microfinance and education, so provide financial education to clients. Before a client can borrow from SPBD they must attend introduction sessions to ensure they understand the terms of borrowing.
Other reasons for a lack of access to banking services include prejudice- banks may refuse entry to the poor. The small transactions that these individuals are likely to make may also make loan officers think it not worthwhile to assist them. MFIs employ people who share its mission and want to help the poor. Also, MFIs specialise in small transactions and aim to reach and provide opportunities to as many people as possible.
Eligibility is the primary barrier to traditional banking for the poor, and naturally the major way in which microfinance has distinguished itself from the traditional banking sector.
There is no way for a bank, with all its technology, to assess the ability of an individual to repay or likelihood of repayment other than to assume that those with more can afford to borrow more. There are many other factors that determine the likelihood of someone repaying their debt, including human characteristics such as trustworthiness. A computer cannot tell whether someone who says they are using a loan for a specific purpose is actually going to use it for this or whether they will be able to repay the loan.
Niall Ferguson in ‘The Ascent of Money’ discusses the idea of credit as a measure of trust. The very reason that banks are able to lend so much and grow is based on the idea that we trust the banks enough to hold our money. The truth is that they don’t actually have all our money, so if we all wanted to pull out our deposits at the same time, the banks couldn’t deliver. They trust that this won’t happen, so they create ‘money’ and lend it to individuals, with the trust that they will repay. With this type of relationship and millions of dollars in single loans, they cannot afford to just lend to ‘anyone’, nor can they afford to get to know each of the millions of individuals that they lend to, when profits are at stake. Consequently there is more incentive for banks to lend to already wealthy individuals with collateral. One generally cannot borrow from a bank without collateral or against future income without a steady job. So how do MFIs lend solely to individuals without either?
They use people of course!
Let me explain how it works here at SPBD Tonga, a modified Grameen Bank model, used by thousands of MFIs across the globe. Villages are broken up into centres, where meetings are conducted each week, and centres are broken into groups of women, all of who know each other reasonably well (a member must have lived in the village for at least 1 year). Each member of a group acts as a guarantor for the other members in that group, and beyond that, each woman in the centre is a guarantor for every other woman. What this means is that, as well as the obligation to pay their own loans, the women also have the obligation to cover others in their group, and centre, should others fail to meet their weekly payment obligation. If these payments are not met, then each member of the group faces a reduction in their next loan cycle, or in extreme cases may not be able to borrow again. Before applying for a loan each woman must explain exactly what they intend to use the loan for, and the centre as a group must agree to the loan. This clever incentive structure gives each woman a reason to make sure that each loan in their group and centre is being used productively, and essentially collect information that the MFI cannot.
Now, initially an MFI has about as much information as a bank might on each client. Over time, as relationships are built between centre managers and their clients, more information on the personal characteristics and circumstances of clients and their businesses will be obtained. Each client ceases to be a number on a computer screen and becomes human with a face, personality, story and reason for borrowing.
Let me finish by returning to Niall Ferguson and the idea of credit as a measure of trust. Where a banks’ ability to lend more and more hinges on our trust in something that isn’t real- the ‘money’ they create, an MFIs ability to lend is through the real relationships and trust that people build with one another. The technology that banks have replaced people with, as brilliant as it may be, cannot measure the very thing that they rely on to make millions: trust. Only people can create, measure and understand trust, and MFIs have used this trust to give opportunities to millions, through this thing we call ‘credit’.