MICROFINANCE HANDBOOK - An Institutional and Financial Perspective pptx

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MICROFINANCE

HANDBOOK

MICROFINANCE

HANDBOOK

An Institutional and Financial Perspective

Joanna Ledgerwood

T H E W O R L D B A N K

W A S H I N G T O N , D . C .

SUSTAINABLE BANKING with the POOR

Copyright © 1999

The International Bank for Reconstruction

and Development/THE WORLD BANK

1818 H Street, N.W.

Washington, D.C. 20433, U.S.A.

All rights reserved

Manufactured in the United States of America

First printing December 1998

Second printing July 1999

Third printing July 2000

The findings, interpretations, and conclusions expressed in this paper are entirely those of the

author and should not be attributed in any manner to the World Bank, to its affiliated organiza￾tions, or to members of its Board of Executive Directors of the countries they represent. The

World Bank does not guarantee the accuracy of the data included in this publication and accepts

no responsibility for any consequence of their use.

The boundaries, colors, denominations, and other information shown on any map in this volume

do not imply on the part of the World Bank Group any judgment on the legal status of any terri￾tory or the endorsement or acceptance of such boundaries.

The material in this publication is copyrighted. Requests for permission to reproduce portions of

it should be sent to the Office of the Publisher at the address shown in the copyright notice above.

The World Bank encourages dissemination of its work and will normally give permission prompt￾ly and, when the reproduction is for noncommercial purposes, without asking a fee. Permission to

copy portions for classroom use is granted through the Copyright Clearance Center, Inc., Suite

910, 222 Rosewood Drive, Danvers, Massachusetts 01923, U.S.A.

Joanna Ledgerwood is consultant to the Sustainable Banking with the Poor Project, World Bank,

for Micro Finance International, Toronto, Canada.

Library of Congress Cataloging-in-Publication Data

Ledgerwood, Joanna.

Microfinance handbook: an institutional and financial perspective/Joanna Ledgerwood.

p. cm.—(Sustainable banking with the poor)

Includes bibliographical references and index.

ISBN 0-8213-4306-8

1. Microfinance. 2. Financial institutions. I. Title.

II. Series.

HG178.2.L43 1998 98–21754

332.1—dc21 CIP

Contents

Foreword xv

Preface xvi

Introduction 1

PART I—ISSUES TO CONSIDER WHEN PROVIDING MICROFINANCE 9

Chapter 1 Understanding the Country Context 11

Suppliers of Financial Intermediation Services 12

Existing Microfinance Providers 14

What Role Do Donors Play in Microfinance? 16

Financial Sector Policies and Legal Enforcement 17

Interest Rate Policies 18

Government Mandates for Sectoral Credit Allocations 19

Legal Enforcement of Financial Contracts 19

Financial Sector Regulation and Supervision 20

When Should MFIs Be Subject to Regulation? 21

Considerations When Regulating MFIs 23

Country Approaches to Regulating MFIs 25

Economic and Social Policy Environment 26

Economic and Political Stability 26

Poverty Levels 28

Investment in Infrastructure and Human Resource Development 28

Government View of the Microenterprise Sector 29

Appendix 1. Risks in the Microfinance Industry 30

Sources and Further Reading 31

Chapter 2 The Target Market and Impact Analysis 33

Objectives of the Microfinance Institution 33

Direct and Indirect Targeting 34

The Importance of Adequate Cash Flow and the Capacity to Service Debt 35

v

vi C O N T E N T S

Minimal Equity Requirement 36

Moral Hazard 36

Market Size 36

Identifying the Target Market 37

Characteristics of the Population Group 37

Types of Microenterprises 42

Impact Analysis 46

Kinds of Impacts 47

What Kinds of Impacts Have We Seen with Microfinance? 48

Impact Proxies 49

Client-Oriented Impact Analysis 49

When Should Impact Be Assessed? 52

Methods of Impact Assessment 53

Fundamental Characteristics of Qualitative Approaches 53

Fundamental Characteristics of Quantitative Approaches 54

Comparisons of Quantitative and Qualitative Approaches 56

Integrating Methodologies 56

The Choice of Unit of Analysis 56

Appendix 1. Quantitative Impact Assessment 58

Sources and Further Reading 59

Chapter 3 Products and Services 63

The Systems Framework 64

Microfinance Institutions—Minimalist or Integrated? 65

Financial Intermediation 66

Credit 66

Savings 71

Insurance 74

Credit Cards and Smart Cards 74

Payment Services 75

Social Intermediation 76

Enterprise Development Services 78

Social Services 81

Appendix 1. Microfinance Approaches 82

Appendix 2. Matching Enterprise Development Services to Demand 86

Sources and Further Reading 90

Chapter 4 The Institution 93

The Importance of Institutions 93

Attributes of a Good Institution 94

The Importance of Partner Institutions 94

Institutional Types 97

Formal Financial Institutions 97

Semiformal Financial Institutions 101

Informal Financial Providers 104

C O N T E N T S vii

Institutional Growth and Transformation 106

Expansion Within an Existing Structure 106

Creating an Apex Institution 106

Creating a Formal Financial Intermediary 109

Governance and Ownership 110

Accessing Capital Markets 113

Institutional Capacity Building 117

Appendix 1. MFI Operational Review 118

Appendix 2. Manual for Elaboration of a Business Plan 123

Sources and Further Reading 128

PART II—DESIGNING AND MONITORING FINANCIAL PRODUCTS AND SERVICES 131

Chapter 5 Designing Lending Products 133

Cash Patterns, Loan Terms, and Payment Frequency 133

Client Cash Patterns and Loan Amounts 133

How Does the Loan Term Affect the Borrower’s Ability to Repay? 134

Frequency of Loan Payments 136

Working Capital and Fixed Asset Loans 136

Loan Collateral 137

Collateral Substitutes 137

Alternative Forms of Collateral 138

Loan Pricing 138

Calculating Interest Rates 140

How Do Fees or Service Charges Affect the Borrower and the MFI? 142

Cross-Subsidization of Loans 143

Calculating Effective Rates 143

Estimating the Effective Rate 144

Calculating the Effective Interest Rate with Compulsory Savings or Other Loan Variables 146

Calculating the Effective Interest Rate with Varying Cash Flows 147

How Does the Effective Cost for the Borrower Differ from the Effective Yield to the Lender? 148

Appendix 1. How Can an MFI Set a Sustainable Rate on Its Loans? 149

Appendix 2. Calculating an Effective Interest Rate Using the Internal Rate of Return Method 150

Appendix 3. Calculating the Effective Rate with Varying Cash Flows 152

Sources and Further Reading 153

Chapter 6 Designing Savings Products 155

Demand for Savings Services 156

Is There an Enabling Environment? 157

Legal Requirements for Offering Voluntary Savings Services 157

Deposit Insurance 158

Does the MFI Have the Necessary Institutional Capacity to Mobilize Savings? 160

Ownership and Governance 160

Organizational Structure 160

Human Resources 161

Marketing 162

Infrastructure 163

viii C O N T E N T S

Security and Internal Controls 163

Management Information Systems 163

Risk Management and Treasury 163

Sequencing the Introduction of Savings Services 164

Types of Savings Products for Microentrepreneurs 164

Liquid Accounts 165

Semiliquid Accounts 165

Fixed-Term Deposits 166

Costs of Mobilizing Voluntary Savings 166

Pricing Savings Products 167

Sources and Further Reading 168

Chapter 7 Management Information Systems 169

An Overview of Issues Related to Management Information Systems 170

Three Areas of Management Information Systems 171

Accounting Systems 171

Credit and Savings Monitoring Systems 172

Client Impact Tracking Systems 178

Installing a Management Information System 178

Institutional Assessment 178

Configuration 178

Software Modifications 179

Testing 179

Data Transfer 179

Training 180

Parallel Operations 180

Ongoing Support and Maintenance 180

Appendix 1. Overview of Commercial Management Information System Software Packages 180

Appendix 2. Criteria for Evaluating Loan Tracking Software 183

Sources and Further Reading 183

PART III—MEASURING PERFORMANCE AND MANAGING VIABILITY 185

Chapter 8 Adjusting Financial Statements 187

Accounting Adjustments 188

Accounting for Loan Losses 188

Accounting for Depreciation of Fixed Assets 192

Accounting for Accrued Interest and Accrued Interest Expense 193

Adjusting for Subsidies and Inflation 194

Accounting for Subsidies 195

Accounting for Inflation 197

Restating Financial Statements in Constant Currency Terms 199

Appendix 1. Sample Financial Statements Adjusted for Subsidies 200

Appendix 2. Sample Financial Statements Adjusted for Inflation 202

Sources and Further Reading 204

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ix

Boxes

1.1 Formal Sector Suppliers in Rural Mexico 14

1.2 Do Microfinance Clients Need Subsidized Interest Rates? 15

1.3 Credit Institutions as a Political Tool: Debt Foregiveness in India 15

1.4 Microfinance in Indonesia 16

1.5 Multilateral Development Banks’ Strategies for Microfinance 18

1.6 The Consultative Group to Assist the Poorest 19

1.7 Usury Laws in West Africa 19

1.8 Alexandria Business Association: Legal Sanctions 20

1.9 Regulating MFIs: The Case of Finansol 22

1.10 Enhancing the Effectiveness of Oversight 23

1.11 Private Financial Funds in Bolivia 25

1.12 Nonbank Financial Institutions in Ghana 26

1.13 Microfinance in Areas of Political Unrest 27

1.14 The Albanian Development Fund 28

1.15 Tax Laws in Argentina 29

2.1 Targeted Credit Activities 34

2.2 U.S. Agency for International Development Findings on Female Borrowers 38

2.3 The Kenya Rural Enterprise Programme 40

2.4 The Influence of Ethnicity and Language in Microfinance 41

2.5 Islamic Banking 42

2.6 The Association for the Development of Microenterprises’ Work with Existing Microenterprises 43

2.7 Foundation for Enterprise Finance and Development’s Approach to Sector Development 46

2.8 The Impact of Finance on the Rural Economy of India 47

2.9 PRODEM’s Impact and Market Analysis Project 50

3.1 Principles of Financially Viable Lending to Poor Entrepreneurs 67

3.2 Individual Loans at Fédération des Caisses d’Epargne et de Crédit Agricole Mutuel, Benin 69

3.3 The Association for the Development of Microenterprises 69

3.4 Rotating Savings and Credit Associations 70

3.5 Repayment Instability in Burkina Faso 71

3.6 The Role of Groups in Financial Intermediation 72

3.7 Caisses Villageoises, Pays Dogon, Mali 73

3.8 Self-Employed Women’s Association Insurance 75

3.9 The Association for the Development of Microenterprises’ MasterCard 75

3.10 Swazi Business Growth Trust Smart Cards 76

3.11 Demand for Payment Services at the Fédération des Caisses d’Epargne

et de Crédit Agricole Mutuel, Benin 76

3.12 Village Banks: An Example of a Parallel System 77

3.13 Social Intermediation in a Social Fund in Benin 78

3.14 Business Skills Training 79

3.15 Direct and Indirect Business Advisory Services 79

3.16 Cattle Dealers in Mali 79

3.17 Who Offers Social Services? 81

3.18 Freedom From Hunger—Providing Nutrition Training with Microfinance 81

A3.1.1 Training for Replicators in West Africa 83

A3.2.1 Policy Dialogue in El Salvador 90

x C O N T E N T S

4.1 Freedom From Hunger: Partnering with Local Institutions 96

4.2 Types of Financial Institutions 97

4.3 Development Banks 98

4.4 Tulay sa Pag-Unlad’s Transformation into a Private Development Bank 99

4.5 The Savings Bank of Madagascar 99

4.6 Caja Social: A Colombian Commercial Bank Reaching the Poor 100

4.7 Caja de Ahorro y Prestamo Los Andes 101

4.8 Accion Comunitaria del Peru 101

4.9 The Rehabilitation of a Credit Union in Benin 102

4.10 CARE Guatemala: The Women’s Village Banking Program 104

4.11 The Use of Self-Help Groups in Nepal 105

4.12 Using the Nongovernmental Organization as a Strategic Step in Expansion 107

4.13 Catholic Relief Services: Using the Apex Model for Expansion 108

4.14 Transformation from a Nongovernmental Organization to Financiera Calpía 110

4.15 Catholic Relief Services’ Guatemala Development Bank 110

4.16 BancoADEMI Ownership Structure 112

4.17 Guarantee Scheme in Sri Lanka 114

4.18 Key Measures for Accessing Commercial Financing 114

4.19 Accessing Capital Markets by Issuing Financial Paper 115

4.20 ProFund—an Equity Investment Fund for Latin America 115

4.21 The Calvert Group—a Screened Mutual Fund 116

4.22 DEVCAP—a Shared-Return Fund 116

4.23 Credit Unions Retooled 118

A4.2.1 Suggested Business Plan Format 125

A4.2.2 Estimating the Market: An Example from Ecuador 126

5.1 The Association for the Development of Microenterprises’ Collateral Requirements 139

5.2 Cross-Subsidization of Loans 143

6.1 Deposit Collectors in India 156

6.2 Savings Mobilization at Bank Rakyat Indonesia 158

6.3 Deposit Insurance in India 159

6.4 Security of Deposits in the Bank for Agriculture and Agricultural Cooperatives, Thailand 159

6.5 Ownership and Governance at the Bank for Agriculture and Agricultural Cooperatives, Thailand 161

6.6 Using Local Human Resources in Caisses Villageoises d’Epargne et de Crédit Autogérées, Mali 162

6.7 The Sequencing of Voluntary Savings Mobilization 164

6.8 Bank Rakyat Indonesia Savings Instruments 165

6.9 The Choice of Savings Products in Pays Dogon, Mali 166

6.10 Administrative Costs for Banco Caja Social, Colombia 167

7.1 Determining the Information Needs of an MFI 170

7.2 Microfinance Institutions with Developed “In-House” Systems 174

7.3 Improving Reporting Formats: Experience of the Workers Bank of Jamaica 176

7.4 Management Information Systems at the Association for the Development

of Microenterprises, Dominican Republic 177

7.5 Framework for a Management Information System at Freedom From Hunger 178

7.6 Running Parallel Operations in the Fédération des Caisses d’Epargne et de Crédit Agricole Mutuel, Benin 180

8.1 The Impact of Failure to Write Off Bad Debt 191

8.2 Cash and Accrual Accounting for Microfinance Institutions 194

C O N T E N T S xi

9.1 Repayment Rates Compared with Portfolio Quality Ratios 208

9.2 The Effect of Write-off Policies 211

9.3 Computation of the Subsidy Dependence Index 220

9.4 CARE Guatemala’s Subsidy Dependence Index 221

9.5 Outreach Indicators 226

9.6 Depth of Outreach Diamonds 228

9.7 CAMEL System, ACCION 229

9.8 Financial Ratio Analysis for Microfinance Institutions, Small Enterprise and Promotion Network 230

9.9 PEARLS System, World Council of Credit Unions 231

9.10 Tracking Performance through Indicators, Consultative Group to Assist the Poorest 232

A9.5.1 Analyzing a Financial Institution’s Return on Assets 238

10.1 Fifteen Steps to Take in a Delinquency Crisis 246

10.2 Unusual Gains in Efficiency at Women’s World Banking, Cali, Colombia 248

10.3 Performance Incentives at the Association for the Development of Microenterprises, Dominican Republic 250

10.4 Performance Incentive Schemes at Tulay Sa Pag-Unlad Inc., the Philippines 251

10.5 Credit Officer Reports at the Association for the Development of Microenterprises 252

10.6 Transfer Pricing at Bank Rakyat Indonesia and Grameen Bank in Bangladesh 253

10.7 Standardization at Grameen Bank 254

10.8 Institution Vulnerability to Fraud 259

10.9 Fraud Control at Mennonite Economic Development Association 260

Figures

1 Relationship between Level of Analysis and Technical Complexity in this Book 5

1.1 Understanding the Country Context 11

2.1 Client Characteristics 38

2.2 Types of Microenterprises 42

3.1 Minimalist and Integrated Approaches to Microfinance 65

3.2 Group Social Intermediation 78

A3.2.1 The Entrepreneur’s Context 86

Tables

1.1 Providers of Financial Intermediation Services 13

1.2 Private Institutions in Microenterprise Development 17

2.1 Enterprise Sector Credit Characteristics 45

4.1 Key Characteristics of a Strong Microfinance Institution 95

4.2 What Is at Stake for Microfinance Owners? 112

A4.2.1 Financial Cost as a Weighted Average 128

5.1 Examples of Loan Uses 137

5.2 Declining Balance Method 140

5.3 Flat Method 141

5.4 Effective Rate Estimate, Declining Balance 145

5.5 Effective Rate Estimate, Flat Method 145

5.6 Change in Loan Fee and Loan Term Effect 146

5.7 Variables Summary 147

A5.3.1 Internal Rate of Return with Varying Cash Flows (Grace Period) 152

A5.3.2 Internal Rate of Return with Varying Cash Flows (Lump Sum) 152

8.1 Sample Portfolio Report 188

xii C O N T E N T S

8.2 Sample Loan Loss Reserve Calculation, December 31, 1995 190

9.1 Sample Portfolio Report with Aging of Arrears 209

9.2 Sample Portfolio Report with Aging of Portfolio at Risk 209

9.3 Calculating Portfolio at Risk 210

9.4 Calculating Portfolio Quality Ratios 212

9.5 Calculating Productivity Ratios 213

9.6 Calculating Efficiency Ratios 215

9.7 Calculating Viability Ratios 219

9.8 Effect of Leverage on Return on Equity 224

A9.5.1 Breakdown of a Microfinance Institution’s Profit Margin and Asset Utilization 239

A9.5.2 Analysis of ADEMI’s Return on Assets 240

10.1 Cost of Delinquency, Example 1 244

10.2 Cost of Delinquency, Example 2 245

10.3 On-Time and Late or No Payments 247

10.4 Branch Cash Flow Forecasts 256

C O N T E N T S xiii