Nout Wellink: Microfinance - small loans, big differences
Speech by Dr Nout Wellink, President of the Netherlands Bank and Chairman of the Basel Committee
on Banking Supervision, at the Roosevelt Academy, Middelburg, 1 June 2007.
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Today is special. You represent the very first graduation year of the Roosevelt Academy, and
undoubtedly there awaits a bright future for you all wherein chances of success will abound. Clearly
your accomplishment also signals the big achievement by the Academy and its faculty members.
Today, I wish to talk to you about another success story, namely that of microcredit.
The UN designated 2005 the International Year of Microcredit. The aim was "building inclusive
financial sectors and strengthening the powerful, but often untapped, entrepreneurial spirit existing in
communities around the world." The Year of Microcredit has proved highly successful. It has raised
awareness around the globe about the importance of microfinance in fighting poverty and empowering
the poor by enhancing higher incomes and more jobs. In other words, microfinance can promote
economic and social inclusion.
Permit me to address the issue of microfinance in greater depth. "Microfinance" generally stands for
financial services for the poor. Microfinance is important because well over three billion people do not
have access to basic financial services such as credit, savings accounts and insurance. Microfinance
can offer such basic financial services, which is of prime importance to these people. These financial
services are provided by so-called "microfinance institutions" (MFIs) or "microlenders", which are
simply generic terms for the estimated 10,000 diverse entities such as commercial banks, NGOs,
credit unions, finance companies etc. While from now on I will have microcredit in mind when referring
to microfinance in general, please keep in mind that microfinance services are much broader and also
include insurance, deposit taking and sometimes even pensions. However, the most important
element of microfinance today is still micro credit.
Let me therefore begin by explaining what microcredit is, how it works and whether it helps poor
people to improve their living standards. Thereafter I will discuss the market for microcredit. In
particular, I will focus on initiatives that have been taken in the Netherlands. With pride I can say that
the Netherlands is amongst the frontrunners when it comes to developing and supporting new
initiatives in the field of microfinance. The fact that Her Royal Highness princess Maxima was a
member of the Advisors Group to the United Nations International Year of Microcredit 2005 has
undoubtedly contributed to the growing involvement of the Dutch in microfinance. And, she continues
her work as a member of the UN Advisory Group on Inclusive Financial Sectors. Finally, by way of a
conclusion I will identify some challenges for the future.
Microcredit - what is it?
Microcredit is the extension of very small loans (micro loans) to the unemployed, to poor
entrepreneurs and to others living in poverty who are not considered bankable. These individuals
typically lack collateral, steady employment and a verifiable credit history. Therefore they cannot meet
even minimal qualifications to gain access to traditional credit. Microcredit is a financial innovation
which originated in developing countries where it has successfully enabled extremely impoverished
people (mostly women) to engage in self-employment projects that allow them to generate income and
to begin to build wealth and ultimately to exit poverty. Thanks to the success of micro credit, many
people in the traditional banking industry have begun to realize that these microcredit borrowers can
be seen as pre-bankable. Microcredit is gaining credibility in the mainstream finance industry. Many
traditional large finance organizations are now considering microcredit projects as a new source of
future growth.
How does microcredit work?
As you all know, microfinance has been invented by Nobel Prize laureate Muhammad Yunus, who
was here last year when he received the Four Freedoms Award by the Roosevelt Foundation. In the
1970's Professor Yunus was working at the Chitttagong University in Bangladesh. At that time, he
started experimenting with providing small loans to the people in the villages surrounding the
university. In 1976 he started the now famous Grameen Bank with help from the government. The goal
was simple: providing small loans to the very poor. Regular banks would not provide such loans
because they considered them too risky - poor people typically lack collateral - and too costly. The
small scale of the loans and high monitoring costs for each individual loan typically increase
operational costs.
An interesting feature of Grameen bank's initial lending methodology is that loans were provided to
groups rather than to individuals. Let me briefly illustrate how some of those first schemes worked in
practice. Two members of a five-person group receive their loans first. If all instalments are paid on
time, the initial loans are followed four to six weeks later by loans to two other members. After another
four to six weeks, the remaining member, known as the group chairperson, receives his or her loan -
of course provided all goes well. In the beginning the group was typically seen as a source of
solidarity. For example, when one member could not repay the loan, the group chairman could help
out. In this way the credit record of the defaulted borrower would remain clean, and thereby also that
of the group as a whole. Over time, formal sanctions by the bank became more common. If one or
more group members failed to repay, all group members would be cut off from future loans. The
incentive to help each other out in times of need, but also to check on each others repayment record,
became stronger through this joint liability system.
In practice the group lending methodology functioned well, as repayment rates were generally high.
Group lending is not only beneficial for the poor people as they gain access to credit, it is also an
advantage for the microfinance institution that is providing the loans. Part of the responsibilities of the
microfinance institution, such as monitoring loans and enforcing repayments, are taken care of through
the group's own checks and balances. In this way the operational costs of microfinance have reduced
and it becomes possible to give poor people loans that would otherwise not be available or at least
would not be available at such low interest rates. The group lending methodology thus increases
social capital and efficiency.
Effect on poverty and economic development
With innovative concepts such as group lending it is possible to give poor people access to credit. An
obvious next question is: what does this credit do for them? Can people actually improve their living
standards with the help of micro credit? There are basically two ways to answer this question. The first
way is to look at the data and the available scientific studies and carefully assess the results. This is
how central bankers typically approach economic questions. The second way is to pack your bags,
hop on an airplane, and see for your self how microcredit affects the lives of people in developing
countries. Let's start with the second approach, which is not so common for central bankers, but
undoubtedly no less illuminating.
My personal experience with microfinance in Ghana has been very positive. And this holds for many
observers who have witnessed the activities of microfinance institutions on the ground. But is
microcredit really an effective means to alleviate poverty? Are the high expectations justified and can
we establish a clear causality between microfinance and higher socio-economic welfare? To answer
this question, we have to go beyond personal experience and also look at the data and results of the
available scientific studies. However, there has been surprisingly little scientific work on the
effectiveness of microfinance programs. According to some experts this may be explained by the fact
that many donors who finance microfinance institutions are focussed on reaching as many poor
people as possible. Evaluating programmes is often seen as a waste of time and money - and let me
say that from a practical point of view such a perception is understandable.
But, from a broader policy point of view, it is important to know which concepts work best and which
concepts are less effective. Careful experimentation with sound control groups may provide such
insights. Another explanation for the limited degree of scientific evaluation is lack of data. Often there
are simply not enough data available to study the effectiveness of microfinance. Moreover, the
available data may be of limited use because, for example, accounting definitions differ between
institutions in the microfinance industry. I therefore welcome recent initiatives, for example by the
World Bank, to improve the quality of reliable data to increase our current knowledge. With these
shortcomings in mind, the available studies provide a rather positive picture of microfinance and
confirm my personal observations. It turns out that microcredit helps people to increase their income
through entrepreneurial activities. The effects are often larger for women than for men and seem to
diminish if the size of the loan increases. This latter result suggests that the smallest loans can
actually make the biggest difference! And that women remain an important target group.
The market for microcredit and initiatives in the Netherlands
The prospect for the microcredit industry in general is strong. The market is growing rapidly and supply
can hardly keep up with demand. It is estimated that only 4 percent of global demand for microfinance
services is being met. Note that the potential global microfinance market is worth roughly $300 billion,
although estimates vary widely. Also, with the growing development of the microfinance sector,
sources of funding for MFIs have diversified. Official donors are no longer the primary source, as tens
of microfinance funds and more and more private sector investors are also offering capital to MFIs and
are rapidly commercialising microfinance. These investors are typically private-sector funding arms of
donors and socially motivated, privately-managed investment funds financed by public and private
capital. Although both types of investors generally take a commercial approach in the rigor of their
investment analysis and monitoring, they are not always fully commercial in the sense of trying to
maximise profit.
The Dutch involvement in microfinance has not been left to chance. On the contrary, already in 1997
the first effort was made to co-ordinate microfinance activities by several co-financing agencies
(Cordaid, Hivos, Interchurch Organisation for Development Co-operation and Novib) and their main
funder the Ministry of Foreign Affairs. With the growing involvement of other private and commercial
organisations in microfinance there was a need to include a larger and more diverse group of actors in
this initiative. So, in January 2003 thirteen organisations agreed to formalise their efforts to co-ordinate
and work together. They jointly established the Netherlands Platform for Microfinance. Dutch
organisations that support the microfinance sectors in developing countries through investments or
subsidies can join. Since its establishment the Platform has grown to comprise fifteen organisations.
To give you some idea of what the Platform does: in 2005 the Platform invested over Eur 360 million in
the form of loans, equity investments, guarantees, seed capital and subsidies; this is up more than
50% from the Eur 225 million in 2004! These investments reached more than 550 organisations in 78
countries that offer financial services to poor people, ranging from community-based organisations,
cooperatives, non-governmental organisations, banks and other financial institutions. A large share of
this money has been invested in Latin America, followed by Asia, Central and Eastern Europe.
Surprisingly, Africa has the lowest share (around 12%). The West still seems to lack the commitment
to truly help this continent forward. The distribution over the four regions has by and large remained
steady over the last three years. This reflects the fact that in general microfinance markets have
matured, especially in Latin America, compared to the development of the sector on the African
continent. But, although the market for microfinance is growing and more and more organisations are
supporting this development, there remain important challenges for the future.
Challenges for the future - by way of conclusion
If we truly wish to succeed in providing microfinance services to the poor on a large scale, further
contributions are desperately needed. This is not only an issue of financing. Regulators and
governments, in particular, need to develop legal and regulatory frameworks for microfinance,
consumer protection, and financial infrastructure. Also prudential supervisors - and as a prudential
supervisor myself I find this very important - can contribute to the growth of microfinance by defining
clear criteria for microfinance institutions. This pertains in particular to institutions that wish to take
deposits from the public or expand their services cross sectorally. And, last but not least, perhaps you
yourselves as successful graduates of the Roosevelt Academy can also make a contribution to the
success of microfinance, as future investors, entrepreneurs, or simply by telling others in your
environment about the potential of microfinance. The latter can actually prove to be very effective, as
you undoubtedly have a bright future as the next generation of influential professionals in our society.