W A Wijewardena: Microfinance - a potent instrument of poverty alleviation
Valedictory address by Mr W A Wijewardena, Deputy Governor of the Central Bank of Sri Lanka, at
the Third Training Program on Microfinance Delivery System, College of Agricultural Banking, Reserve
Bank of India, Pune, 16 March 2007.
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It is indeed an honor for me to deliver the Valedictory Address on the occasion of the conclusion of the
Third Training Program on Microfinance Delivery System in Pune. The Central Bank of Sri Lanka
made a request to the College of Agricultural Banking, a renowned training institute on microfinance,
to prepare a tailor-made training program for its staff and microfinance practitioners engaged in its
poverty alleviation projects. The College, popularly known as CAB, very kindly agreed to this. After the
exchange of several correspondences between the two institutions, the training program was finally
arranged. Two batches of trainees have already followed the program and enjoyed the hospitality
which CAB had offered them. Back at home, those trainees have spoken very high of the quality of the
training imparted to them by CAB. I am sure that those who pass out today in this third program too
will return to Sri Lanka with the same high opinion on CAB's professional standards.
Microfinance is a very potent instrument of poverty alleviation. It fills the gaps which normally arise in
macro-type poverty reduction policies pursued by governments. The usual strategy adopted by
governments to attack poverty has been the attainment of a high economic growth continuously over
the long run. With that growth, it is expected that the benefits of economic uplifting would trickle down
to lower levels of the society. As a result, the overall economic conditions of all segments of the
population would elevate to a higher level. It will kill the absolute poverty levels. Some good examples
are countries like Malaysia and South Korea. Both these countries were able to reduce absolute
poverty from a very high level of over 50 percent to a very low level below 6 percent within about four
decades.
If macroeconomic growth can tackle poverty, the n why should one be bothered about microfinance?
The reason is very clear. When macro-policies are adopted, there are certain gaps that are created in
the alleviation of poverty. As a result, some segments of the society would experience a worsening of
their situation. This is because all the people in a society are not capable of moving along with the
market at the same speed. Some move faster than the market. They are the super-performers and
stand to gain more. Some move at the same rate as the market. They attain a gain more or less
equivalent to the market performance. There is no problem about both these categories. That is
because they have the capacity to look after themselves. The problem arises in the case of people
who are unable to move forward at the speed of the market. They become laggards and are left out.
Hence, there should be a special strategy to bring them to the mainstream of economic life.
The normal strategy that had been adopted to address this issue has been the introduction of safety
nets to capture them before they make a free fall to the ground. The safety nets so introduced have
taken different forms depending on the era or the country. About five decades ago, the safety nets
took the form of providing outright grants to the poor people. The objective of the grants was to provide
some relief to them, so that they could at least meet their food requirements. The weaknesses in this
type of strategies are well known. It encourages poor people to remain in the safety net forever. They
have no incentive to move out of the net, because moving out would mean their having to work hard
for a living. If at least the basic requirement of food is provided free of charge, then why would anyone
want to work for the same? Economists have long named this problem "moral hazard" problem. This
problem simply says that, when one helps another, the person being helped does not have the
incentive to adopt even the minimum safety measures. As a result, he increases the chance of the
occurrence of the event which the helper desires to prevent. The consequence is that it imposes an
additional burden on the helper. As a result, neither the helper nor the helped would be able to get out
of the vicious circle in which the both parties would get trapped.
The moral hazard behavior by people who get free goods is not a new phenomenon. It had been
known for many centuries. The Buddha has preached in one of the discourses titled Chakka Vatti
how the king of a country was duped by the people who were given free capital to
Seehanaada Sutta
commence self-employment projects. According to this Sutta, the people of a certain country had
resorted, in large numbers, to theft and robbery. The king had consulted his wise advisors to find how
to eliminate it. The advice given was that people had resorted to theft and robbery, because they had
no a way of earning a livelihood. Hence, to enable them to start self-employment projects, the king
opened his treasury and allowed them to take whatever the money they needed for use as capital.
After some time, the people realized that if they resorted to more theft and robbery, they could get
more money from the king. As a result, instead of such felonies declining, they indeed started to rise in
the kingdom.
A similar example has been attributed to the Chinese philosopher, Confucius, who lived in the 5th
century BC. One day, when he was returning from the river after a fishing expedition, a beggar, sitting
by the side of the road, was reported to have asked him for a fish. "I'll not give you a fish. Instead, I'll
tell you how you could catch a fish" Confucius is reported to have told the beggar. The moral of the
story was that if the beggar was given a fish, he would get used to the free fish and beg for it
everyday. Then, it would have been a severe burden on Confucius. So, he advised the beggar to
depend on himself rather than begging from others.
The experience in poverty alleviation throughout the globe has shown that safety nets in the form of
outright grants do not work in the long run. Hence, the safety nets that were introduced earlier were
converted to "safety ropes". Those safety ropes were expected to provide a means for the poor to
hang onto and then climb upward with the support given to them. Thus came the era of microfinance
which indeed was a safety rope through which the poor could cross the poverty line. Such
microfinance would help them to attain the goal of getting out of poverty, provided certain conditions
are met.
The training program conducted by CAB teaches us these conditions which are needed for the
sustenance of microfinance schemes. The experience throughout the world tells us that microfinance
alone is not sufficient to eliminate poverty. This is because microfinance satisfies only the funding
requirements of micro-enterprises. But, funding is only one aspect of a micro-business. Prior to as well
as subsequent to funding, there are a large number of other requirements that have to be satisfied.
First and foremost, anyone desirous of starting a micro-business should have a good knowledge of the
market in which he would sell his products. A feature of the market is that it is driven by the consumer
who is considered the sovereign. If the consumer does not need a product, no one could force him to
buy it, even when it is supplied free of charge. Hence, the goods and services that are produced by
micro-businesses should always meet the requirements of the consumers.
How can a micro-entrepreneur identify the market requirements? What proxies can he use for that, if
he does not have direct information on the same? A problem which he would face in this respect is
that he has to produce for the future. Hence, any information relating to the past may be a poor guide
for that. This is not a problem unique only to micro-businesses. It is equally relevant to big producers
as well. But the advantage for such big business firms is that they have the benefit of the results of
consumer preference surveys conducted by various institutions. Such survey results are expensive
and beyond the financial capacity of micro-businesses. Yet, without the benefit of such results, it would
be a pure gambling for a micro-business to get into the production of these goods and services. In a
world where information is costly, this would be a serious blow to the potential micro-entrepreneurs.
What this means is that if correct information is not available, micro-businesses are doomed to fail.
Hence, in the delivery of microfinance, it is equally important to arm the micro-entrepreneurs with
accurate market information regarding the consumer preferences. Though such information may be
costly to a single user, it may not be so if all micro-entrepreneurs get together and acquire the
necessary information wholesale. Such information could be kept in an information bank maintained at
microfinance institutions. Since it is not advisable to provide such information free of charge, due to
the potential moral hazard problem, a fee should be charged from the users. In addition, microfinance
institutions too could conduct such market research and disseminate the required information among
their customers. That should also be provided at a price.
Another important requirement of micro-businesses is the need for preparing micro-business plans.
The necessary technical know-how for this is not available with the ordinary micro-entrepreneurs. It
requires them to prepare the estimates of cash flows, market sales, funding requirements, legal and
marketing aspects and business disaster management techniques etc. Once they are put into a
generally accepted format, then only they would be acceptable to the lending banks. It is necessary
that all the potential micro-entrepreneurs should be knowledgeable of preparing such business plans.
If they cannot do that, they could engage specifically trained business plan consultants for the
preparation of those plans at a fee.
This was experimented in one of the development projects implemented by the Central Bank of Sri
Lanka. In this particular project, bank financing was available for both micro and small businesses.
One of the requirements of banks was the submission of a comprehensive business plan, acceptable
to the banker, by the prospective micro-borrowers. But, none of the borrowers had the capacity to
prepare them. As a result, the utilization of the moneys in the project became a problem. As a solution,
it was decided to outsource the function to some business development consultants at a cost to the
borrowers. Accordingly, a number of youth who had studied economics, business studies and
accounting for the GCE Advanced Level were selected for training as business consultants. Then,
they were appointed to provide consultancy services to potential entrepreneurs for a fee. The lending
banks also paid a certain commission to them for services such as loan recovery and follow up work.
The program worked well and a new generation of fee-based business consultants was developed by
the project. At the end of the project, most of these consultants, having used their own expertise,
started their own businesses.
Another pertinent issue involved in microfinance delivery is how to reduce the transaction costs and
make available the loans at the time they are needed by the borrowers. The transaction cost is simply
the additional resources which a person has to spend, other than what is paid to the supplier, in order
to complete a transaction. In the case of borrowing, transaction costs include any payment which the
borrower has to make other than the payment of interest to the lender. Such costs, therefore, comprise
legal fees, application fees, loan processing fees, any bribes or commissions payable, stamp duties
and other taxes and, finally the opportunity cost of the time spent for pushing the application through
bureaucracy and the waiting time. This can be compared with a village money lender who is alleged
to be charging an exorbitantly high interest rate. Yet, the transaction costs involved in borrowing from
a money lender is practically zero. Hence, from an efficiency point of view, a village money lender is
preferable to a microfinance institution with a high transaction costs.
In Sri Lanka, in late 1980s, the Central Bank ran an agricultural credit scheme of which the interest
rate payable by the farmer had been fixed at 9 percent when the market interest rates amounted to
about 20 per cent. The subsidy was intended to reduce the farmers' cost of production and promote
agriculture. A study conducted by ADB revealed that the effective interest rate paid by farmers, after
taking into account all the costs, amounted to 30 percent, much higher than even the free market
rates. The difference between the actual cost incurred by the farmer and the rate paid by him to the
lending bank was wastage of resources. It had not been the income of anyone. Hence, such costs are
known as deadweight losses. Microfinance institutions should, therefore, strive to keep the
transaction costs at a minimum and eliminate the possibility of incurring deadweight losses.
The on-time delivery of microfinance loans is also a very important requirement. Most of the
microfinance projects are agriculture based businesses. Hence, there is a necessity for meeting
crucial expenses on-time. For instance, if a farmer has to apply fertilizer to his field, he has to do it on
the due date. For him to buy fertilizer, he needs money also on the due date. This requires the
microfinance institutions to release their loans on the due dates. Any undue delay would be immensely
costly.
A final word should also be said about the subsidization of the interest rates under microfinance credit
schemes. Such subsidized credit is demanded, not by the microfinance borrowers, but by urban
based social workers and politicians. The problem with subsidized credit is that it flows not into the
microfinance projects but elsewhere. What microfinance borrowers need is not cheap credit. They
need credit on simple terms in time at zero transaction costs. When the credit is subsidized, it not only
leads to wastage, but also goes into the hands of undeserving individuals. Most probably, middle class
and lower middle class people would flock to appropriate such credit which they plan to use for other
types of non-productive purposes. In this context, informal money lenders would definitely provide a
role model for microfinance institutions. Instead of trying to fight the money lenders, microfinance
institutions should learn good management practices adopted by them.
All in all, microfinance delivery is a very subtle subject which should be handled very carefully. The
best practices of microfinance lending are common to all countries. But, there may be a necessity for
such countries to vary the actual implementation based on the specific country requirements. This
arises from the famous dictum that one shoe will not fit all the feet. For the size and the variance of
each and every foot, a different variety of a shoe has to be made. I hope that the participants of this
training program have acquired this wisdom and would return to Sri Lanka armed with that wisdom.
Thank you.