The microcredit movement has proved to be revolutionary in providing financial access to the low-income households, especially in developing countries. Though the fundamental idea behind microfinance comes from the 15th century, the 1980’s saw the introduction of the Grameen Bank and the idea that low-income households were a viable market for financial services. During the 1990’s the microfinance industry started to develop by building financial systems. The industry witnessed rapid growth and expansion in the 2000’s.
The exponential growth and promising rate of returns attracted a lot of investors – private and public. Much of the equity and debt came from foreign investors, domestic banks, and domestic investors. In order to be sustainable the microfinance industry focused on developing a self-sustainable business model, which in turn allowed service providers to scale up and reach more and more low-income households. Because of this scaling up the ‘big-earner’ of a financial service – the ‘credit’ product, witnessed outstanding growth. Microfinance has been dominated by ‘micro-credit’ ever since. The credit product accounted for almost all of the growth of a typical microfinance institute. The ‘outstanding loan portfolio’, which was really the outstanding credit portfolio, became a buzzword.
However, studies have shown that the poor need ‘savings’ as a product as much as they need the ‘credit’ product. For the poor, the alternative to microfinance industry is the informal sector. Although the informal sector is a robust system, the interest rates are generally around 60% and can reach 120% or higher in many cases. Further, historically, issues like bonded labor, land acquisition and lack of confidentiality have been associated with the informal sector.
There is enough evidence to say that the microfinance industry gives poor people the dignity that they deserve while making financial transactions. But why has the industry focused only on developing credit or loan products and not on other products like savings, insurance and remittances?
Savings products have not yet been developed in most countries for a number of reasons. First, regulations restrict the licensing of banks and hence most microfinance institutions are run as Non-Banking Financial Company (NBFC). NBFCs, unlike banks, cannot accept deposits from people. This is often defended as a mechanism to protect the poor’s money. Second, the poor have very micro sized savings that they often draw on and so the savings products must meet their temporal needs. Striking the balance of flexible products and operational costs is always a challenge. Third, while savings products can help reduce the cost of funds for a microfinance institute, it could not support the rapid growth the industry witnessed. The global growth of the microfinance industry is a result of the money pumped in by organizations that find the interest on credit attractive.
The poor also need insurance as a product to protect themselves from unforeseen events. Poor people’s lives are the most vulnerable to shocks: may it be health, injury, job loss or death. The impact of these shocks can have a lifelong impact – increasing vulnerability and magnifying future risks. Historically the microfinance industry offered a credit linked life insurance to their clients, which basically waived off the loan payments in case of death or at times even returned the previous payments to the family. However, a number of international development organizations and big insurance companies have attempted to design other insurance products for the poor. The challenges in the implementation of micro insurance are liquidity constraints due to insufficient and irregular cash flows in poor households. Further, the poor have not always understood the risks associated with the shocks in their life and therefore the benefits of insurance. Financial literacy has been and will be an important element in providing financial services to the poor. Even if they understand the importance of the insurance product, there are behavioral issues that could restrict the poor in using it to their benefit. Hence, there is a need for insurance as a product but the demand is questionable because of lack of financial literacy, understanding of the insurance product, and behavioral issues. This makes providing insurance product challenging.
However in order to meet the goal of using financial inclusion as a tool to aid in poverty alleviation microfinance needs to fulfill all of the needs of the poor with respect to financial services. Therefore, an ideal product mix including credit, savings and insurance products complemented with processes that are convenient for the poor must be developed. Product mixing can eventually help lower operational costs making the industry more sustainable and distribute benefits to the more and more poor households.