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p. 1 of 24 BACK | NEXT Introduction Need for a Development Strategy for Microfinance Microfinance in the Asian and Pacific Region ADB’s Microfinance Experience Other Agencies’ Microfinance Experience ADB’s Microfinance Development Strategy Implementation of the Strategy

Microfinance Development Strategy

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Introduction

The interest in microfinance (defined in Box 1) has burgeoned during the last two decades: multilateral lending agencies, bilateral donor agencies, developing and developed country governments, and nongovernment organizations (NGOs) all support the development of microfinance. A variety of private banking institutions has also joined this group in recent years. As a result, microfinance services have grown rapidly during the last decade, although from an initial low level, and have come to the forefront of development discussions concerning poverty reduction.

Despite this growth, as concluded in the recently completed Rural Asia Study, “rural financial markets in Asia are ill-prepared for the twenty-first century.”¹ About 95 percent of some 180 million poor households in the Asian and Pacific Region (the Region) still have little access to institutional financial services. Development practitioners, policy makers, and multilateral and bilateral lenders, however, recognize that providing efficient microfinance services for this segment of the population is important for a variety of reasons.

1. Microfinance can be a critical element of an effective poverty reduction strategy. Improved access and efficient provision of savings, credit, and insurance facilities in particular can enable the poor to smoothen their consumption, manage their risks better, build their assets gradually, develop their microenterprises, enhance their income earning capacity, and enjoy an improved quality of life (Box 2).² Microfinance services can also contribute to the improvement of resource allocation, promotion of markets, and adoption of better technology; thus, microfinance helps to promote economic growth and development.

   Box 1: Definition of Microfinance Microfinance is the provision of a broad range of financial services such as deposits, loans, payment services, money transfers, and insurance to poor and low-income households and, their microenterprises. Microfinance services are provided by three types of sources: formal institutions, such as rural banks and cooperatives; semiformal institutions, such as nongovernment organizations; and informal sources such as money lenders and shopkeepers. Institutional microfinance is defined to include microfinance services provided by both formal and semiformal institutions. Microfinance institutions are defined as institutions whose major business is the provision of microfinance services.

2. Without permanent access to institutional microfinance, most poor households continue to rely on meager self-finance or informal sources of microfinance,³ which limits their ability to actively participate in and benefit from the development opportunities.
3. Microfinance can provide an effective way to assist and empower poor women, who make up a significant proportion of the poor and suffer disproportionately from poverty.
4. Microfinance can contribute to the development of the overall financial system through integration of financial markets.

Box 2: Microfinance poverty reduction nexus
Financial service	Results	Impact on poverty
Savings Facilities of microfinance institutions (MFIs)	More financial savings Income from savings Greater capacity for self-investments Capacity to invest in better technology Enable consumption smoothening Enhance ability to face external shocks Reduce need to borrow from money lenders at high interest rates Enable purchase of productive assets Reduce distress selling of assets Improve allocation of resources Increase economic growth	Reduce household vulnerability to risks/external shocks Less volatility in household consumption Greater income Severity of poverty is reduced Empowerment Reduce social exclusion
Credit Facilities	Enable taking advantage of profitable investment opportunities Lead to adoption of better technology Enable expansion of microenterprises Diversification of economic activities Enable consumption smoothening Promote risk taking Reduce reliance on expensive informal sources Enhance ability to face external shocks Improve profitability of investments Reduce distress selling of assets Increase economic growth	Higher income More diversified income sources Less volatile income Less volatility in household consumption Increase household consumption Better education for children Severity of poverty is reduced Empowerment Reduce social exclusion
Insurance Services	More savigs in financial assets Reduce risks and potential losses Reduce distress selling of assets Reduce impact of external shocks Increase investments	Greater income Less volatility in consumption Greater security
Payments/Money Transfer Services	Facilitate trade and investments	Greater income Higher consumption

Developing countries in the Region have used microfinance services to reduce poverty. About 21 percent of the Grameen Bank borrowers and 11 percent of the borrowers of the Bangladesh Rural Advancement Committee, a microfinance NGO, managed to lift their families out of poverty within about four years of participation.⁴These services also had a significant positive impact on the depth (severity) of poverty among the poor. Extreme poverty declined from 33 percent to 10 percent among Grameen Bank participants, and from 34 percent to 14 percent among Bangladesh Rural Advancement Committee participants. Without exclusively targeting the poor, the unit desas of the Bank Rakyat Indonesia (BRI) have also assisted “hundreds of thousands of households in lifting themselves out of absolute poverty over the past decade.”⁵ A 1988 sample survey of unit desa borrowers showed that microcredit has had a major impact on their families' standards of living. The study estimated that net household incomes of borrowers increased by about 76 percent and employment increased by 84 percent with three years of program participation.⁶ The studies have, in general, shown that microfinance services have also had a positive impact on specific socioeconomic variables such as children’s schooling, household nutrition status, and women’s empowerment.⁷ Microfinance institutions (MFIs) have also brought the poor, particularly poor women, into the formal financial system and enabled them to access credit and accumulate small savings in financial assets, reducing their household poverty. However, researchers and practitioners generally agree that the poorest of the poor are yet to benefit from microfinance programs in most countries partly because most MFIs do not offer products and services that are attractive to this category.⁸ Thus, to increase the overall impact of microfinance on poverty reduction, it is essential to extend a wide range of services on a continuing basis to the poor who are still excluded from the benefits of microfinance.

Providing microfinance services efficiently to this excluded segment of the market remains a major challenge in the Region. However, given that the Asian Development Bank (ADB) has adopted poverty reduction as its overarching objective, ADB must respond to this challenge effectively. Supporting the development of sustainable MFIs that can reach the poor provides ADB an opportunity to respond to this challenge and make a significant contribution to its poverty reduction objective and the development of the overall financial system in its developing member countries (DMCs). This paper, which was prepared through extensive consultation involving ADB’s DMCs, other funding agencies, and external experts in microfinance (Appendix 1), proposes a development strategy for institutional microfinance covering the services provided by both formal and semiformal sources. The paper addresses three major concerns:

1. What should be the strategic directions in ADB's assistance to its DMCs to expand the frontier of institutional microfinance to include the poor who are currently excluded and those who are likely to be excluded in the future?

2. How should ADB support improvement of the quality of microfinance services in the Region?

3. How can ADB help expand microfinance services to achieve the maximum development impact, including a reduction in the incidence of poverty?

Thus, the strategy defines ADB’s role in the development of microfinance in the Region and covers qualitative and quantitative dimensions. The strategy is formulated within ADB’s overall strategy for poverty reduction.

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