Microfinance institutions (MFIs) began as community-based savings and credit organisations: working practices were defined by local needs. What has changed? Microfinance now focuses on financial sustainability and some MFIs have become banks - of a sort. Others have developed cooperative linkages with commercial banks. What are the long-term implications of these changes? Research by the London School of Economics considers this question drawing on practice in Zimbabwe, Tanzania, Ghana, and Mozambique. The study is cautious about the long-term potential advantages of these linkages and examines the issues surrounding the mainstreaming of microfinance in Southern Africa.

Microfinance institutions in Africa are small and underdeveloped. They lack the institutional capacity to reach large numbers of clients and yet have the right skills and expertise to cater for the poor. Commercial banks, on the other hand, although typically serving a more affluent clientele, have superior institutional capacities and wide geographical coverage.

The paper suggests that policymakers have a range of institutional choices in seeking to improve microfinance provision and establish linkages between MFIs and banks. These include commercial banks gearing down to provide services to small and medium businesses and low-income consumers, and NGOs upgrading by adopting management practices from the corporate sector and acquiring banking licences. Decision makers need to understand the purpose, role, and limitations of such linkages, as well as the longer term process of moving microfinance into the commercial mainstream. The study reaches a number of key conclusions:

• Financial liberalisation and institutional diversification in the financial sectors have reduced the gap between MFIs and commercial banking.
• With increased pressure for financial sustainability, microfinance NGOs have moved towards financial professionalism.
• Potential for cooperation dwindles when banks start testing the microfinance market for themselves and NGOs transform into formal financial institutions.
• Competition in supplying microfinance raises new problems for microfinance managers, donors and policymakers regarding MFI institution-building and market regulation.
• Regulation requires an arms-length approach, but institutional development needs a more interventionist strategy. Regulatory efforts are hampered by limited range of supply.
• The success of linkage depends on MFIs remaining different from banks - especially in terms of their target group and product range.

Policy recommendations to governments and donors include the following:

• MFIs should maintain technical links with banks, but not base their strategies on close co-operation: banks should be seen as potential long-term competitors.
• The need for diverse microfinance sectors: without competing suppliers, competition and choice, no real microfinance market can develop.
• Capacity building programmes should focus on microfinance markets more than on individual suppliers. The resource requirements for the institutional development of market participants are substantial.
• Efficient markets require appropriate regulation and supervision. The development of a regulatory framework is integral to a microfinance development strategy, but needs to be separate from institution building.

Source(s):
'Cooperation or Competition? The Institutional Development of Microfinance in Southern Africa' by Jens Reinke, mimeo, CREFSA (1999)

Funded by: UK Department for International Development (Escor)

id21 Research Highlight: 1 December 2000

Further Information:
Jens Reinke
Centre for Research into Economics and Finance in Southern Africa (CREFSA)
London School of Economics
London WC2A 2AE
UK

Tel: 0044 (0)20 7955 7280
Fax: 0044 (0)20 7955 6954
Contact the contributor: j.reinke@lse.ac.uk

Centre for Research into Economics and Finance in Southern Africa (CREFSA), London School of Economics

Other related links:
Mobilising resources towards the progress of the African continent

The UNCDF Special Unit for Microfinance assist rural African MFIs

The International Finance Corporation promote private sector investment in developing countries

Search Microfinance Gateway - an online forum for microfinance topics

Search the Eldis directory for links to further financial research