What is the best way for very poor people to borrow money? Can formal, regulated financial institutions reach the poorest and achieve financial sustainability? Research by the UK Overseas Development Institute in Bangladesh, Thailand, Peru, Colombia and Bolivia, casts doubt on the efficacy of formalisation - the transformation of an NGO-based microfinance institution into a formal bank - and suggests that it is far from the perfect solution. If financial sustainability succeeds at all, it may only do so at the cost of denying the poorest parts of society access to financial services.

Microfinance in the five countries studied was enthusiastically embraced as an ideal strategy to help the very poor gain access to finance. In the wake of economic and political change however, microfinance institutions (MFIs) have developed three key strategies in an attempt to reach the poorest households at the same time as ensuring their own sustainability. The three strategies are: formalisation of MFIs; penetration, or the ability of formal institutions to reach the poorest; and linkages between formal and non-formal institutions. However, several problems have arisen:

• The poorest - an unprofitable customer base - are excluded from services offered by the newly formalised MFIs.
• The poorest of existing clients can feel marginalised and are often driven away by the transformation of MFIs for example, to institutional culture, premises, staff, or types of services offered.
• The poorest are simply not reached by commercial banks or alliances between formal and informal financial institutions.
• Linkages between commercial banks and self-help groups often fail because of poor commitment and conflicts of interest (between shareholders and management for example)
• Formalisation has depleted social capital - both the networks between poor people and the relationships between the poor and the NGOs aiming to help them.
• The focus on the needs of the poor is being lost through formalisation.

Lessons for policymakers include the following suggestions:

• Formalisation does not lead automatically or naturally to increased access for very poor people to funding.
• Careful evaluation by donors of the timing of any withdrawal of funds from NGOs and of the pressure being put upon NGOs to become self-sustaining is essential.
• Greater participation by poor clientele is needed in MFI decision-making processes, particularly as financial products are designed or management structures set up.
• Voluntary (rather than top-down) linkages between local financial markets, grassroots organisations and poor households could emerge to act as financial providers for the poor.

Source(s):
'How can finance work for the poor? Strategies to reach the poor sustainably', by Ana Marr (forthcoming)

Funded by: UK Department for International Development (ESCOR)

id21 Research Highlight: 7 July 2000

Further Information:
Ana Marr
Overseas Development Institute
Portland House
Stag Place
London SW1E 5DP
UK

Tel: +44 (0) 20 8555-1943
Fax: + 44 (0) 20 7393-1699
Contact the contributor: a.marr@odi.org.uk

Overseas Development Institute, UK

Other related links:
Search Eldis for sources on microfinance