Because the microfinance industry often targets low income households, the industry typically must work with government welfare programs either as a competitor, ally, or supervisor. In every country this relationship is a little different depending on the stage of development of the microfinance industry. In all of them, however, managing this relationship is crucial to the success of both microfinance and government welfare programs.
Historically, governments have implemented social welfare programs for the poor that also included providing loans. The form of lending is usually called targeted lending. Targeting lending can be thought of as credit given for some specific activity and is almost always in the form of a subsidized loan. Governments and international organizations have been particularly active in extending targeted loans for agriculture. However, historically, these programs have often not been successful due to inappropriate credit rationing decisions, lack of information about cash flows and credit capacity of low income households.
It is into this gap that microfinance has stepped. The success of the microfinance industry in providing credit to low income households has been recognized by governments and international organizations, which have supported the expansion of their programs. They have made funds available and adapted policies that aid the development of microfinance institutions. Doing so has expanded access to credit for millions of poor households in ways that government programs had previously failed to manage. However, the government has not abdicated its role as a regulator. In an effort to protect the market and the poor, the government also acts as a supervisor of microfinance institutions.
In most countries, the ecosystem of financial services to the poor is still in the development stage and so it is crucial to define the role of government. Although the microlending product has been successful in many places, the industry is still struggling to successfully roll out micro savings and micro insurance as viable products. In this early stage then the government can act as a crucial player and aid in the development of the industry. By adjusting policies to incentivize the private sector – like India’s priority sector lending – the government can build regulatory frameworks that help financial institutions to effectively implement multiple products. Doing so will create a fully functional financial system for the poor. For example: savings mobilization is not allowed in some countries; while it is allowed in others. Stepping in here and adopting policies for promoting savings product would allow the expansion of the product portfolio to populations in need. The government can also play a critical role in building a credit bureau system that can address issues like over indebtedness. Standardizing Know Your Customer documents would reduce the challenge of working with the different forms of identification that poor people have in most countries.
By making use of the network of microfinance industry the government could also implement support programs for better health and promising education for the low income households by developing programs like conditional cash transfers for health and education.
Since the market segment of the microfinance industry is the low income household, a complementary relationship with the government serves the interests of both the industry and government welfare programs. The microfinance industry cannot provide a full suite of financial services without some government support. Regulations designed for large banks can be particularly constraining for microfinance programs with different clients and programmatic needs. On the other hand, the government is aided in its obligation to provide welfare services to citizens by the work of the microfinance programs. Working together will prove to be very valuable for both and will make financial services accessible to low income households. Ultimately this leads to an economy with a fully inclusive financial system.
Image Credit: Nichalp via Wikimedia Commons
