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p. 16 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 Goal and Purpose Strategy Strategic Focus Implementation of the Strategy

Microfinance Development Strategy : ADB’s Microfinance Development Strategy

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Strategic focus

Policy environment

Financial sector reform programs have resulted in a general improvement of the policy environment in the Region. However, in many countries, lack of an enabling policy environment for microfinance continues to be a major constraint. Hence, this issue must be addressed effectively. Thus, ADB will broaden the scope of financial sector reform programs to include issues concerning microfinance. The policy reforms will focus on interest rate reforms relevant for microcredit and savings within the broader financial sector reforms, creating an environment sufficiently flexible to accommodate a wide range of MFIs and OFIs to meet the diverse demand, and redefining the role of the state and the central banks in microfinance development to facilitate participation of private sector financial institutions. Given that nonfinancial policies such as agricultural pricing and taxation of microenterprises also have a critical role in sustainable development of microfinance, the policy reforms will be extended to address such issues where they constitute significant constraints. ADB will not go beyond policy-related operations in countries where the policy makers are not committed to adopting appropriate reforms for sustainable development of microfinance. When policy reforms are built into specific projects, exit conditions will be clearly spelled out and enforced in the event of noncompliance.

Policy reforms may be effectively carried out when commitment to and ownership of reforms are generated within DMCs and a long-term partnership is established between ADB and the DMCs. Thus, it is necessary to closely consult with all major stakeholders in formulating microfinance policy reform programs for DMCs.

Financial infrastructure

Underdeveloped financial infrastructure continues to constrain the deepening and broadening of microfinance services and participation of private institutions as service providers. While MFIs in some DMCs, such as Bangladesh, have grown without a proper financial infrastructure, such growth, based partially on public deposits, can pose a systemic risk within the microfinance subsector. MFIs can develop sustainable commercial services on a permanent basis, and expand their scope of operations and outreach, only if they operate within an appropriate financial infrastructure. The improved financial infrastructure contributes to the development of the entire microfinance subsector, not just one specific institution. Therefore, ADB’s assistance will focus on critical elements of financial infrastructure, such as information systems and training facilities necessary for microfinance development. In some countries, legal barriers also prevent banks from establishing business relationships with informal or semiformal bodies such as community-based organizations or self-help groups. The legal framework and supervision and regulation of MFIs are important mainly because they facilitate sound growth and improve the capacity of MFIs to leverage funds in the market and provide competition. However, ADB will ensure that legal and regulatory systems will not discourage financial innovations, stunt institutional growth, and prevent emergence of a diverse set of dynamic institutions. Depending on country contexts, ADB will also support development of self-regulation and performance standards for MFIs.

Institutional development

ADB, in consultation with its DMCs, has identified institutional capacity building as an important requirement for sustainability and expanding outreach.²⁸ Strong institutions with good governance are required to provide quality services to the poor on a permanent basis. A good MFI with a commitment to provide microfinance services to the poor should have the capacity in particular to

1. mobilize resources in the market, including public deposits, to meet its resource requirements;
2. provide products and services that are attractive to the poor at minimal transaction costs to the clients and the institution itself; and
3. offer competitive prices to the clients.

Financial viability is critical for expanding the outreach. Only viable financial institutions involved in microfinance can ensure permanency of services to an increasing number of the poor and contribute significantly to poverty reduction. Thus, financial viability of the institutions committed to serve the poor is seen as a tool to achieve the primary objective of outreach. For the same reasons, the strategy emphasizes institutions providing a broad range of financial services to the poor and low-income households, and microenterprises. These diversified institutions have a better chance to (i) achieve viability within a short period than the institutions that focus exclusively on the poorest clients, and (ii) reach more of the very poor than exclusively-focused institutions. However, ADB needs to support institutions to develop and offer products and services compatible with the socioeconomic characteristics of the poor to improve their access to permanent services and to reach the poorest of the poor.

ADB’s institutional development activities will focus largely on existing MFIs and other financial institutions with a commitment to provide microfinance services to the poor. In countries where state-owned agricultural and rural development banks continue to undermine development of sustainable microfinance operations, ADB will explore possibilities for and support reforms of such banks (Box 4). However, in some circumstances, especially in transitional economies that lack appropriate institutions to efficiently provide microfinance services, new institutions may be needed. The establishment of such new institutions will be based on the potential for financial viability and capacity to expand the outreach to a significant number of the poor. ADB will also support development of apex microfinance organizations where necessary conditions for their sustainable operation exist.²⁹

The institutional development activities also need to encompass

1. development of training facilities for the microfinance sector,
2. ownership and governance of financial institutions involved in microfinance,
3. development of a diversified menu of products and services attractive to the poor,

   Box 4: The Unit Desas of the Bank Rakyat The Bank Rakyat Indonesia (BRI), with its unit desa system, is a successful rural financial institution with a large microfinance portfolio. Before 1984, BRI unit desas were channelling subsidized credit, and mobilized very little savings. The Bank Indonesia provided funds to BRI at 3 percent per year for onlending at 12 percent per year to rice farmers under the Government's rice intensification program, known as Bimas. In addition, the Government subsidized the administrative costs of BRI unit desas. The unit desas incurred large operating losses and experienced increasing default rates. In 1983, the default rate was about 50 percent. With large losses and default rates, the Government was compelled to terminate the Bimas program in 1983. Discontinuation of Bimas meant that BRI faced the problem of what to do with about 3,600 unit desas and 14,000 employees. The financial reforms of 1983, which liberalized interest rates, provided the opportunity for the Government to reform the unit desa system. Under the reform program, the unit desas adopted market-oriented interest rates on loans (about 33 percent per year), and were transformed into full-service rural banking outlets. BRI also started to treat each unit desa as a profit or loss center. New savings products were introduced under the reform measures. The reforms produced dramatic results, transforming unit desas into profitable rural financial intermediation outlets. The unit desas, which incurred a $28.0 million loss in 1983, made a profit of $34.0 million in 1991. As of the end of 1999, unit desas had 24.2 million deposit accounts with a total outstanding deposit of about $2.27 billion equivalent and 2.5 million borrowers with a total outstanding loan amount of $781 million equivalent. The average outstanding deposit size was about $94, while loan size was about $318. Despite the crisis in the financial sector, during 1999, unit desas generated a profit of about $153 million. The unit desas continue to operate as an integral part of the state-owned BRI. Sources: ADB. 2000. Rural Asia Study: Beyond the Green Revolution. Manila: ADB and Bank Rakyat Indonesia.

4. management information systems and accounting policies and practices,
5. management of portfolio quality and growth, and
6. systems and procedures and financial technology for reducing transaction costs.

Pro-poor innovations

The development of sustainable financial institutions will contribute to the expansion of their outreach to the poor. However, while improving the institutions' capacity in general to serve a wide spectrum of the poor is important, this is not sufficient to ensure that their services are made available to certain categories of the poor, such as those in resource-poor and low-population density areas, the poorest of the poor, and ethnic minorities. Often, financial institutions tend to exclude these categories due to risk-return considerations, although the social returns to reaching these clients may be high. Private institutions are, in general, reluctant to invest in financial technology and innovative programs oriented to the poor because they tend to believe that the market among the poor is limited and externalities will not allow them to profit from their investments. Therefore, to ensure that the financial institutions will continue to expand the services to these categories, ADB will support innovative programs and development of financial technology that contribute to breaking these barriers through pilot projects and other measures that aim at establishing sustainable linkages between formal financial institutions and informal service providers. ADB will also support development of pro-poor products and services and delivery mechanisms because these are essential to attract the poor into the formal sector.

Social intermediation

Social intermediation is necessary to increase the capacity of the majority of the poor to access and productively use microfinance services. Hence, the strategy emphasizes supporting investments aimed to improve the capacity of the poor to actively participate in microfinance markets. Such investments will cover, among other things, (i) awareness building programs on a broad range of microfinance services; (ii) information dissemination on service providers; (iii) basic literacy, numeracy, and skills training for women, ethnic minorities, and other disadvantaged groups; and (iv) social mobilization for formation of community-based organizations and solidarity groups to actively participate in microfinance markets.

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