Four questions to ask before funding a microfinance project

Posted on July 28, 2011 at 8:00 am

While I’m on hiatus this summer I’m reposting interesting posts that readers may have missed before.

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Microfinance is growing in popularity both among donors and the aid world. If you’re uncertain about how microfinance works or what are its strengths and weaknesses, see my post What is Microfinance?

Before you donate, use these four questions to help you determine whether the charity is following best practices. These questions and all quotes are based upon CGAP‘s Good Practice Guidelines for Funders of Microfinance , which is well worth reading if you’re serious about funding microfinance programs.

Question # 1: What alternatives to loans are also available?

Microloans are not always the best choice, does the charity provide other financial services such as savings accounts or insurance policies? Savings accounts and insurance policies provide a safety net during the bad times and can build value over time. Another plus is that savings accounts pay interest rather than charging it. Money transfer services are also important as they help family members support each other financially.

According to CGAP’s Key Principles of Microfinance in their Good Practice Guidelines for Funders of Microfinance the first principle is:

1. Poor people need a variety of financial services,not just loans. In addition to credit, they want savings, insurance, and money transfer services.

In their lessons learned section they state:

  • Poor clients need and are willing to pay for a variety of financial services (e.g., credit, savings, money transfers, payments, insurance), not only microenterprise loans.
  • Poor people, even very poor people, save. Often savings are made informally, in kind, or in other relatively insecure ways (e.g., animals, jewelry, cash under the mattress).
  • The destitute have very limited absorptive capacity for debt and often no income to repay loans. Microcredit thus may not be the most appropriate solution for them. Similarly, microcredit may not be appropriate for every situation (e.g.,refugee resettlement).

Question #2: Has the charity done due diligence on the financial service providers?

Charities providing microfinance services rarely administer the loans or savings accounts themselves but instead work through local microfinance institutions (MFI). What has the charity done to vet the microfinance institutions it works with? How has the charity determined that the institution has the capacity and ability to handle the number of loans or other financial services it has to administer? Has enough information been gathered to determine that the MFI is something more than just a loan shark?

From CGAP’s Operational Guidelines Section:

  • Conduct due diligence to ensure financial service providers have sufficient institutional capacity and commitment before engaging in product development; do not push financial institutions to develop services that overload their capacity.

Question #3: Are there consumer protection measures in place?

What consumer protection measures would you want if you were applying for a loan, opening a savings account, or paying for insurance? Does the charity you are considering supporting ensure that these measures are in place in every MFI they support?

From CGAP’s Operational Guidelines:

  • Support consumer protection measures aimed at safeguarding poor clients from predatory lenders.The range of measures includes clear disclosure of the true costs of lending, guidance on lender practices, mechanisms for handling complaints and disputes, and consumer education/financial literacy.

Question #4: Does the charity support capacity building of the MFI’s?

The ultimate goal of charities working with microfinance should be to ensure that microfinance institutions become self-sustaining and are able to continue to provide quality financial services indefinitely. Although it may feel great to think that your donation helps fund a specific project or person, you would not want your access to loans and other financial services to be affected by the whims and preferences of people half way around the world. People in developing countries should not have to live with that uncertainty either. How does the charity support capacity building and self-sufficiency of the MFI’s it partners with?

From CGAP’s Lessons Learned:

4. Microfinance can pay for itself, and must do so if it is to reach very large numbers of poor people. Unless microfinance providers charge enough to cover their costs, they will always be limited by the scarce and uncertain supply of subsidies from donors and governments.

5. Microfinance is about building permanent local financial institutions that can attract domestic deposits, recycle them into loans,and provide other financial services.

Good microfinance projects are not about providing loans to individuals, but about developing reliable, fair, and self-sustaining financial services

It is critical that donors see past the allure of donating to a single individual and look at whether the charity is following best practices. Having access to reliable and fair financial services can help people“…raise income, build their assets, and cushion themselves against external shocks.” For this to happen charities needs to be investing in the development of a variety of financial services, ensuring that the MFI’s have the capacity and ability to offer reliable and fair financial services, that consumer protection measures are working, and that the MFI will remain viable long after donor interest wanes.

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Related Posts:

What is Microfinance?
Get to know Industry Standards and Best Practices
“Philanthropy is important and serious work. It does require time and thought”

 

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