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Annual Report 2004 : Special Theme: The Changing Face of the Microfinance Industry: Building Financial Systems for the Poor
Meeting Future ChallengesThe once almost exclusively donor-dependent Asian microfinance industry has evolved to become an industry with a diverse set of institutions offering an increasingly wide range of products and services, not just microcredit. However in most countries, the industry is led by a small group of niche market microfinance institutions that vary in vision, strategy, character, operational style, and qualities. Most of them are flagship institutions in their respective countries while some are global success stories. The rapid growth of their operations is leading to increasing polarization; some of them are already market leaders and others are on the way to consolidating their positions. This group includes not only regulated banking institutions but also regulated nonbank financial institutions and NGOs. They operate like most other established, profitseeking, private companies but with a social mission to serve the poor. This group will continue to grow leaving behind the institutions with lackluster performances and a lack of drive to achieve scale and sustainability. Not only their efficiency but also their greater access to semicommercial and commercial sources of funds will fuel their rapid growth. The operations of these institutions will reinforce the integration of microfinance into the broader financial system. Although potentially sustainable and already sustainable small microfinance institutions need support to expand their operations, it is unlikely that they will provide the scale of financial services necessary for the poor in countries such as the PRC and India. If microfinance services are to be relatively quickly scaled up on a sustainable basis in countries with large potential markets, established private sector financial institutions with large infrastructure need to be encouraged to enter the market. For this to occur, financial systems must be more competitive to drive such institutions to look at the bottom of the market pyramid as a potential source of profit. ICICI Bank's entry into microfinance has set an example in India. However, in countries with large unserved and underserved markets, many such banks must enter, not just one. At the same time, it may also be essential to look at the opportunities presented by AFIs with extensive branch networks and to take action to reform and restructure them to provide financial services for the poor. The transformation of Unit Desas of BRI and of the state-owned Agricultural Bank of Mongolia deserves more attention in this respect. In both cases, reforms enabled rapid scaling-up of services on a profitable basis. It is also necessary to unleash the untapped potential of national savings banks and postal savings institutions in a similar manner. Although the changes that are taking place in the industry as a whole seem to point to brighter prospects for financial systems for the poor, all stakeholders have to work hard to ensure that poor and low-income households have permanent access to financial services. Governments have a critical and constructive role to play. Experience shows that financial services for the poor are sustainable and expand rapidly when governments develop sound policy and legal frameworks, ensure macroeconomic stability, and encourage competition in financial markets instead of directly providing financial services to target groups. Governments can make a significant contribution to developing financial services for the poor by maintaining macroeconomic stability. Nothing is more harmful for microfinance than high inflation. Consistently low inflation rates help the microfinance industry to achieve high growth rates; high inflation rates erode the capital of microfinance institutions and retard their growth. Governments should allow the private sector and NGOs to play a dynamic role in microfinance. An effective way to do this is to avoid direct service provision by government agencies and interest rate caps that reduce the attractiveness of microfinance to the private sector. Governments should improve legal and regulatory frameworks to encourage private sector investment in microfinance institutions and to ensure institutional diversity in microfinance markets and should also make sure that agencies responsible for supervising financial institutions are capable of doing so. Furthermore, it is important that governments increase investments in rural infrastructure and improve law and order to reduce both the risks and transaction costs of providing financial services. Currently most institutional microfinance is confined to areas with relatively better facilities. Finance ministries, central banks, and other government institutions need to recognize that services for poor and lowincome households are an integral part of the financial system. A system that serves only a minority of the population of a country is unacceptable. Inclusive financial systems should be a central goal of every developing member country government of ADB. Giving prominence to this goal and working toward it will help governments to end financial exclusion, reduce poverty, and achieve the Millennium Development Goals. However, the most powerful forces that may lead to a quantum jump in the scale of financial services for the poor will most likely come from the technological changes that reduce risk and transaction costs and from market liberalization and product and process innovations that increase competition in domestic financial markets.
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