Communication from the Commission to the Council and the European Parliament - Microfinance and poverty reduction
Date: 1998-09-30
Institutions: European Commission
Subjects: financial institution, microeconomics, non-governmental organisation, poverty

COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 30.09.1998 
COM(1998) 527  final 

COMMUNICATION FROM THE COMMISSION 
TO THE COUNCIL AND THE EUROPEAN PARLIAMENT 

Microfinance and Poverty Reduction 

CONTENTS 

1. 

P U R P O SE  OF  T H IS  C O M M U N I C A T I ON 

2. MEETING THE CHALLENGE OF POVERTY REDUCTION 

2.1 Poverty reduction: policy framework 

2.2 Poverty Reduction: Main Areas of Activity 

3. THE ROLE OF MICROFINANCE 

3.1 Trends in EC support to savings and credit 

3.2 Microfinance: Some Definitions 

3.3 Poverty reduction and financial sustainability 

3.4 Economic and sociological context 

3.5 Gender aspects 

3.6 Growth and development of microfinance institutions 

4. SUPPORTING MICROFINANCE OPERATIONS 

4.1 Policy Objectives 

4.2 Favourable policy environment 

4.2.1 Macroeconomic policy 
4.2.2 Financial Sector 

4.2.2.1 Preconditions of donor support 
4.2.2.2 Links to commercial financial services. 
4.2.2.3 Regulatory environment 
4.2.2.4 Donor support 

4.2.3 Good governance and microenterprise 
4.2.4 Removing Gender Biases 

4.3 Working with Microfinance Institutions: 

4.3.1  Identification 
4.3.2 Appraisal 

4.3.2.1 External factors 
4.3.2.2 Internal factors 

4.3.3 Implementation: Startups 
4.3.4 Implementation: Establishment 
4.3.5 Implementation: Integration into Commercial Systems 

4.3.5.1 Guarantee Funds 
4.3.5.2 Apex Organisations 

4.3.6 Implementation: Monitoring performance 
4.3.7 Evaluating Impact 

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4.4 Common standards of donor support 
4.4.1 Donor funding: a careful approach 
4.4.2 Strategies for Donor Support 

5. DONOR COORDINATION 

5.1 International level 

5.2 European Union: Community and Member States 

5.3 Country level 

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1.  Purpose of this Communication 
There  has  been  a  recognition  by  the  EC  and  Member  States  that  microfinance,  developed 
mainly  by  NGOs,  can  be  an  important  instrument,  amongst  others,  in  the  fight  against 
poverty.  A  key  principle  is  that  donor  agencies  support  the  development  of  financially 
sustainable  institutions,  rather  than  separate  projects.  These  are  frequently  in  the  private 
sector, but support is generally channeled through the public  sector. 

Although  the  numbers  of  microfinance  institutions  have  increased  substantially  over  recent 
years,  the  establishment  of  microfinance  as  a  sustainable  instrument  in  the  fight  against 
poverty  is  faced  with  various  constraints  of a policy  and  institutional  nature.  EU  assistance, 
along with that of other donors, can be beneficial  in overcoming these constraints. 

The main aim, therefore,  of this Communication  is to provide, in response  to a request by the 
Council,  a coherent  policy  framework  for  Community  microfinance  operations  and  a  basis 
for coordinating activities with Member  States.  The policy set out in this Communication  has 
relevance, therefore,  to both the EC and the Member States. 

The Communication  is one of several papers that deal with different  aspects of support  for  the 
private  sector.  The  main  aim  of  this  paper  is  not  promoting  the  development  of  the  private 
sector,  but  with  developing  the  capacity  of  microfinance  activities  to  reach  the  poor. 
Nonetheless, in crucial areas it is consistent with the approach adopted in the other papers. 

In Section 2 the challenge of poverty for EC development policy and practice  is outlined. The 
main  components  of the policy  and  instruments  for  the  EC to meet  this challenge  is then  set 
out.  Section  3  then  defines  microfinance  as  a  new  instrument  for  the  EC  to  meet  the 
challenge  of poverty.  This  section  looks at  some of the  factors  that  help  in  the  fight  against 
poverty  and  contribute  to  the rapid  growth  of  microfinance  institutions.  A key  concern  has 
been  to ensure that these  institutions remain  financially  sustainable.  Section 4 discusses  how 
the  Community  and  Member  States,  along  with  other  donors,  can  give  support  to 
microfinance.  Crucial  issues are the need to create a favourable  policy  framework,  the  types 
of  support  that  can  be  given  at  different  stages  in  the  life  cycle  of  the  institutions,  and  the 
adoption  of  common  standards  for  donor  support.  The  final  section  deals  with  the  issue  of 
donor coordination, at the international, European and country levels. 

2.  Meeting the Challenge of Poverty Reduction 

Poverty  is still  the greatest problem  facing  the world,  despite  successes  by  some countries  in 
reducing  poverty  and  improving  human  development  indicators.  More  than  one  quarter  of 
the people in less developed  countries  are poor.  More than  1.3  billion  people  live  in  poverty, 
and more than half of them go hungry every day. 

There  is  general  agreement  among  donors  that  sustained  economic  growth  is  important  for 
reducing  poverty,  either  by  increasing  employment  or  by  generating  resources  to  improve 
social  services.  However,  the  World  Bank  and  UNDP  note  that  the  growth  rate  achieved, 
especially  in  Sub-Saharan  Africa,  has been  insufficient  to prevent  the  rise  in poverty.  There 
is now general  agreement  that action  needs  to be taken  so that  economic  growth  benefits  the 
poor  more  directly,  for  example  by  stimulating  employment  and  productivity.  This  general 
agreement is also in line with EU policy, as outlined below. 

2.1  Poverty reduction: policy framework 

The  1992  Treaty  on  European  Union  [Article  13Ou],  puts  the  fight  against  poverty  in 
developing  countries  as one of its three aims. The Resolution  on the  Fight  against Poverty  in 
Developing  Countries,  adopted  by  the  Council  on  2  December  1993  on  the  basis  of  a 

It  is  well  known 

the  issue  as  a  priority. 

communication  from  the Commission  [COM(93) 518 final, dated  16 November  1993], more 
specifically  defined 
that  women  are 
disproportionately  represented  among  the  poor.  The  Council  Resolution  on  Integrating 
Gender  Issues  into  Development  Cooperation  [12847/95  (Presse  374) dated  20  December 
1995] recognises that redressing gender disparities is a crucial issue for development, and that 
the  formulation  of all policies  should  take  account of this issue. The requirement  to integrate 
the  poverty  and gender  issues  into  general  development  policy  was further  strengthened  by 
the  Resolution  on  Human  and  Social  Development  [11913/96  (Presse  329-G)  dated  22 
November  1996].  The Communication to Council on cooperation with ACP countries [COM 
(97)  537  final,  dated  29  October  1997]  refocuses  Community  policy  on  employment 
generating economic growth, poverty reduction, and integration into the world economy. 

These  texts  establish,  in a coherent  manner,  the principles,  objectives,  conditions  and broad 
outlines of a gender  sensitive poverty reduction  policy within the framework  of development 
co-operation. At the same time they emphasise the importance of strengthening  co-ordination 
with the Member  States in this  field. 

2.2  Poverty Reduction: Main Areas of Activity 

The  European  Commission  has engaged  in the following  areas of activity  in the fight against 
poverty: 

Support to the Social  Sectors 

Microprojects  Programmes 

Support to Food  Security. 

Decentralised cooperation, including NGO  cofinancing. 

These  activities  have  been  funded 
instruments  -  European 
Development  Funds (EDF) allocated to National  and Regional  Indicative Programmes,  funds 
in  association  with  Structural  Adjustment  (e.g.  STABEX  funds,  Structural  Adjustment 
Support Funds (SASF), Counterpart Funds), funds  for decentralised  cooperation.. 

through  various  financial 

These  areas  of activity  will  remain  fundamental  in the EU fight against  poverty,  but there is 
scope in the fight against poverty for developing new areas of activity, such as microfinance. 

3. 

The role of micrcfinance 

3.1 

Trends in EC support to savings and credit 

There have been two co-existing models of assistance: 

credit as a component of an integrated  project 

support to decentralised  financial  institutions 

A  study  in  1993  of 22 EC projects  in Asia  and 33 in  Latin  America  showed  that  the first 
(project) model had been dominant. It estimated that 35% of the funds  were allocated to credit 
(i.e. 272 million  ECU), as a component of larger projects. The first model had been  dominant 
within  ACP countries, according to a recent  evaluation  of rural  savings and credit  in 60 ACP 
countries  but,  from  1994, there  had  been  an  evolution  towards  the  second  (institutional) 

model.  From their database, the evaluators identified  some 40 examples of the second model 
in ACP countries, with an allocation of about 90 MECU. 

The second model  is supported by current thinking among donors and practitioners.  There is 
an  international  consensus  that  microfinance  institutions  are  more  sustainable  than  credit 
components  of projects,  and  that  donors  should  provide  support  to the  development  of  such 
institutions. 

3.2  Microfinance: Some Definitions 

There  is  a  wide  range  of  activities  involving  finance  at  the  micro  level  in  the  different 
geographical  areas covered by the European Union development agencies. 

For the purpose of this communication, working definitions have been adopted as follows: 

"Microenterprise"  refers  to  productive  activities  undertaken  in  the  informal  sector, 
whether  these  activities  are  to  produce  or  distribute  goods,  or  provide  services. 
Typically, in ACP countries, a microenterprise employs fewer than 5 workers, usually 
family  members,  and has fixed assets of less  than  $10,000.  The  microentrepreneurs 
need to make use of finance  services to build up their businesses. 

"Microcredit"  refers  only to the provision of loans. The loans are usually  small  - less 
than $1000.  These loans are often used to start up or expand microenterprises.  Some 
lending  institutions  began  by  giving  credit  and  then  extended  their  services  to 
savings. 

"Microfinance"  describes  the provision  of  a range  of  financial  services  (eg  savings, 
credit,  and  insurance).  Savings  deposits  are  small  and  regularly  made.  Loans  are 
also small; the first loan may be only $50, depending on the institution  and its clients. 
A good repayment record may lead to larger loans, or access to other services. 

A "Microfinance  Institution" has clients, women and men, who are mostly  from  poor 
households,  self-employed,  or  engaged  in  microenterprise. 
It  provides  services  in 
various forms  to suit the clients'  needs. A limited  range  of non-financial  services  (eg 
business  advice)  might  also  be  included.  All  the  services  are  provided  on  a 
sustainable basis. The institutions have the ability  to become  financially  viable  within 
a reasonable time frame  and achieve a significant  level of outreach. 

Formal  banks  have  not  generally  been  interested  in  small  savings  and  loan  accounts  and  do 
not  undertake  microfinance  directly.1  The  staff  do not  have  the required  economic  or  social 
skills.  A  facilitating  or  intermediary  institution,  closer  to  the  poor,  is  usually  needed.  This 
institution  links  an  appreciation  of  the  social  context  with  formal  economic  and  financial 
into 
management  considerations.  Various  kinds  of 
microfinance  institutions.  They  may  be  savings  and  credit  institutions,  local  associations, 
credit  unions, NGOs,  and  rotating  and  non-rotating  institutions.2  Occasionally  they  may  be 
more formal  sector institutions like a post office  savings bank, or rural bank. 

that  have  developed 

institution 

According  to  the  World  Bank  there  are  presently  several  thousand  of  these  microfinance 
institutions. 

1  There are a few cases of commercial  banks that run successful  microfinancc schemes; Bank  Rakyat  Indonesia is 

one such example,  but the scheme is separate from  normal banking operations. 

2 There are various rotating or non-rotating  institutions such as Arisan in Indonesia, Paluwagan in Philippines, 

Chit fund  in India, Sittu in Sri  Lanka, Ho in Vietnam, Jia in China, Esusu in Nigeria, and Djanggi in Cameroon. 
The terminology "rotating" and "non-rotating" refers to the way funds  are accessed by participants. 

3.3 

Poverty  reduction  and  financial  sustainabiiity 

Developed  mainly  by  NGOs,  microfinance  institutions  have  become  an  important,  and 
relatively  new, element  in the  fight  against  poverty. Many  practitioners,  recognising  that  the 
poor already made savings in non-financial  forms  such as livestock and trees, regard  financial 
savings services as more important than credit. The primary  aim of microfinance,  therefore,  is 
to provide a financially  sustainable  vehicle for  savings by the poor.  Since poor people  require 
a range  of services, other  financial  services  are also being  developed, such  as  insurance.  By 
mobilising  these  savings  among  poor  people,  credits  can  be  made  available  for  a  variety  of 
productive  purposes.  Loan  security  is provided  in  various  ways.1'.  Over  time,  as  repayments 
are made, people can take larger loans and thus progress out of poverty. 

Organisers  of microfinance  institutions  usually  try  to  achieve  two  objectives:  to  extend  their 
outreach  to  the  poor  and  remain  financially  sustainable.  There  can  be  tensions  between  the 
two  objectives.  Small  scale  savings  and  loans  operations  can  be  an  effective  mechanism  for 
reaching  the poor but there has often  been  a drift  away  from  the poor  as the  institution  seeks 
financial  sustainability. 

Such  a drift  away  from  the  poor  is not  an  inevitable  consequence  of  having  two  objectives. 
Microfinance  institutions  seek  to expand  their  client base by  developing  innovative  products 
for  greater  numbers  of  clients,  and  by  charging  appropriate  rates  for  services.  These 
institutions  try  to  create  greater  access  to  groups  of  people  who  have  so  far  been  excluded 
from  financial  services.  This  is  a  large  potential  client  group  including  the  poor,  women, 
youth,  and  the  elderly  with  diverse  requirements.  By  creating  a  new  market  for  financial 
services  among  these  neglected  groups  and  managing  the  costs  of  service  provision, 
lending 
microfinance 
institutions. In this way, the microfinance  institutions aim to become financially  sustainable. 

institutions  can  attract,  over  time,  the  support  of  commercial 

Because  of  the  difficulty  of  gaining  access  to  formal  financial  services,4  the  poor  regard 
access  to  these  financial  services  as  more  important  than  the  cost  of  the  services.  These 
clients  are  willing  and  able  to  pay  for  financial  services  suited  to  their  demands.  Even  with 
interest rates  set to cover  the  full  costs of operations,  the cost  of the  services  is less than  the 
credit of a money-lender. 

There are inherently greater costs associated  with providing  financial  services to the poor  (for 
example, many small savings accounts in remote, sparsely populated, rural  areas rather  than a 
few  large  loan accounts  in urban  areas).  The microfinance  institution  must therefore  seek  to 
reduce  costs,  even  as  it  extends  its  outreach.  One  instrument  for  this  is,  of  course,  good 
financial  management  of the institution, trying to reduce  costs where possible.  Another  is to 
develop alternative financial  services that respond to the needs of the clients.  By reaching out 
to  greater  numbers  of  poor  people,  the  overall  costs  can  be  reduced  by  reducing  the 
proportion of overhead costs within the overall costs of the services.  Some difficult  decisions 
may  also have  to  be  made,  such  as  deferring  the  provision  of  services  to  some  difficult  to 
reach groups until the institution has more solid financial  foundations. 

3  The most famous example is provided by Grameen  Bank that pioneered the idea of peer pressure within  a grour 

of five beneficiaries.  Other institutions have adopted  their own forms  of security appropriate to the local 
culture 

4 Informal  financial  services are widespread. They do not usually provide a basis for achieving  sustained  increases 

in income levels for a large number of people, though there are examples  in the West African  literature of 
entrepreneurs financing,  over a reasonable time, the growth of relatively  large scale businesses through  rotating 
institutions. In general  informal  financial  services serve diverse purposes of financing  consumption,  providing 
for school  fees, and health  insurance. 

Although  the  microfinance 
institutions  can  reach  many  excluded  groups  and  remain 
financially  viable,  studies have  shown  that,  while  they reach  people  below  the  poverty  line, 
they  do  not  reach  down  to  the  very  poorest  10-15%  of  the  population  (lacking  financial 
resources).  At  present,  the  needs  of  the  poorest  will  continue  to  be  met  mainly  by  non-
financial  services  (eg  social  sector  support).  Many  microfinance  institutions  are  trying  to 
develop alternative financial services that respond to the needs of the poorest. 

There  is  increasing  recognition  that  governments  and  donors  aiming  to  support  the 
development  of  microfinance 
to  the 
sustainability  of  the  microfinance  institutions.  The  problem  has been  to  know,  in  detail,  the 
effects  on  sustainability  of particular  instruments  of  government  and  donor  assistance.  What 
is regrarded at present as the best practices are set out in section 4. 

to  reduce  poverty  should  give  policy  support 

3.4 

Economic and sociological context 

For  Microfinance  schemes  to  be  successful  in  reducing  poverty,  there  must  be  potential 
economic  opportunities,  however  small,  for  local  people  to  exploit.  These  opportunities  are 
not  necessarily  in  the  rural  areas  where  most  of  the  poor  live. It  has  been  noted  that  many 
rural  savings  flow  out  of  the  countryside  to urban  investments,  where  the returns  are  better. 
Microfinance  schemes  may  not  be  successful  in  remote  rural  areas  with  very  poor,  sparse 
populations,  poor  transport  infrastructure  and  other  links  to  towns.  It  may  be  that  other 
methods  of poverty  reduction,  such  as  improvements  to  social  infrastructure,  including  rural 
roads, are better  suited to these conditions.  Alternatively, microfinance  schemes may have to 
develop  other  financial  instruments,  such  as  insurance  against  agricultural  risks,  to  be 
successful  in such areas. 

Micro finance appears  to  be  particularly  successful  in  communities  where  there  is  a  high 
degree  of  social  trust.  (The  selection  of  women's  groups  appears  to  increase  this.  Gender 
issues  are  dealt  with  below).  The  institutional  arrangement  of  having  small  savings  groups 
builds on such relationships of trust. 

There  are  many  other  social  and  cultural  issues  that  are  not  fully  understood.  Cultural 
attitudes to money and savings, systems of local social control, and local practices must all be 
properly  understood  and  addressed  in  designing  a successful  scheme.  The  practice  adopted 
by  microfinance  institutions  is to  ensure  that  local  organisers  are  close  to the  local  situation 
and  to  allow  flexibility  in  the  procedures.  This  works  well  enough  when  microfinance 
activities  are  starting  up, but  may  pose  some problems  when  institutions  are  larger,  trying  to 
manage a diverse clientele and provide management information  to commercial partners. 

There has been  relatively  little research  on the above issues, compared  to institutional  studies 
of  successful  schemes,  so there  is still  work  to be  done to understand  effectiveness.  Further 
research should include: 

Market research (what do the poorest need?) 

Operational research (How are they best served?) 

Social  research  (Attitudes  and  behaviour  relevant  to  the  sector,  geographical 
conditions, relevance of social trust). 

3.5  Gender aspects 

To  be  effective  at  reaching  those  people  who  are  under  the  poverty  line,  microfinance 
institutions  must  give  attention  to  gender  issues  i.e.  taking  into  account  the  needs  and 
constraints of both men and women when designing and delivering financial  services. 

To  improve  their  poverty  focus,  many  institutions  have  given  emphasis  to  the  targeting  of 
women. There is some justification  for this. 

* 

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•  More women are poor, and their poverty is usually greater than men's. 

• They  often  handle  small  amounts  of  cash  and  do  not  seek  high  value  and  risky 
investments. 

• Women  usually  have responsibility  for  the family  so the  impact  on poverty  reduction 
tends to have greater impact than when men gain services. 

•  Concerned  with  family  welfare  ,  they  are  more  inclined  to  save  than  to  indulge  in 
conspicuous consumption  (e.g. alcohol). 

• Women's  access  to  financial  services  is  more  constrained  than  men's,  usually 
because  they  lack  land  or  collateral.  Therefore  they  are  very  conscientious  about 
protecting their access to credit by paying back loans. 

* 

• They  are  able  to work  effectively  in  small  groups,  so the  selection  of women  further 
strengthens the degree of social trust. 

Whether  the rationale  for  targeting  women  is universally  valid  is open  to question,  but  these 
ideas  about  the  role  of  women  appear  to  be  held  by  the  organisers  of  microfinance 
institutions.  The  exact  role  of  gender  relations  in  microfinance  is  still  subject  to  discussion. 
The  importance  of  the  issue  is  whether  these  beliefs  will  prove  useful  to  microfinance 
organisers as microfinance  activities increase, and the constraints on women gaining access to 
credit and making larger investments are reduced. 

Many  microfinance  institutions  have  often  targeted  women,  but  they  deliberately  avoid  an 
exclusive  focus  on  women.  When  men  are  denied  access  to  financial  services,  loans  to 
women  are  hijacked  and  domestic  violence  against  women  may  increase.  The  financial 
discipline of men may also be enhanced when they have to access credit through their wives. 

A  more  gender  sensitive  approach  is  to  provide  differentiated  services  that  respond  to  the 
needs of women and men. For instance, hire purchase  schemes can allow women  and men  to 
pay  for  larger  assets.  Other  institutions  are  developing  health  insurance,  life  insurance,  with 
profit endowment policies etc. 

Some Microfinance Services Convenient to Women. 

Small loans. 

Rapid access to loans (approval in less than a week). 

Flexible 
repayment  schedules; 
repayments with a first small loan. 

regular  and 

frequent 

Collateral  using  items  women  likely  to  have,  eg  jewelry. 
(Otherwise,  group security). 

Small savings accounts. 

Credit  delivery  and  savings  collection  procedures  to  suit 
women's  schedules  and  the  increased  need  for  physical 
security. 

3.6  Growth and development of micro finance institutions 

There  has  been  substantial  growth  in  the  numbers  of  microfinance  operations  during  the 
present decade.  The World Bank estimates that loans and  savings are increasing by  30% per 
year,  generated  by  the  increased  number  of  institutions  being  established.  While  there  are 
evident  risks  in  the  fast  growth  of  new  unregulated  institutions,  much  of  the  growth  is 
experienced by established  institutions. 

In supporting  the  development  of microfinance,  donors have increasingly  taken  the  approach 
of  trying  to  help  bridge  the  gap  between  commercial  financial  services  and  these 
microfinance  institutions.  To do so, there has been a move towards institutional  development 
of  the  microfinance  organisations  themselves  and  a  search  for  innovations  in  financial 
services  which  will  attract  the  large  scale  formal  financial  sector  to  become  involved  in 
microfinance.  Some donors have developed  start-up programmes,  focusing  on how  to  create 
new  microfinance  institutions,  while  others  have  been  concerned  with  the  development  of 
established  institutions. 

4. 

Supporting Microfinance Operations 

4.1  Policy Objectives 

The  overall  objective  of the  EU  development  policy  is to promote  sustainable  and  equitable 
economic growth. There are three major  aspects to this aim: 

To reduce poverty 

To promote economic growth 

To ensure development is sustainable 

There  are  several  lines of action  and  instruments  available  to the EU to reduce poverty, both 
indirectly  and  directly.  Microfinance  institutions  are  recognised  as  another  instrument.  It 
responds to all three aspects of the EU objective. 

There  is  a need  for  a coherent  policy  framework  and  donor  standards  for  the  EU  support  of 
microfinance  institutions. These factors  are discussed in the following  sections. 

Favourable policy environment 

4.2 
Microfinance  requires  a  favourable  policy  environment  to  thrive.5  The  EC  and  Member 
States  should  therefore  appraise  carefully  the  policy  environment,  and  work  together  to 
resolve some of the problems that constrain the development of microfinance.6  The EC is also 
producing  a  Communication  on  Private  Sector  Development  in  ACP  countries.  This  will 
reinforce  some  of  the  points  made  in  this  section  about  support  to  microfinance  and 
microenterprise. 

The macroeconomic  policy  framework  and other policy  issues which affect  the  microfinance 
sector should be discussed at a high level with  governments.  Donors with an overview of the 
sector and macroeconomic  issues could be involved in this. 

5 Microfinance  can survive as an enclave  in an adverse policy environment for a short time, but its ultimate 
sustainability  and capacity for growth arc impaired.  For further  information  on the favourable  policy 
environment  see the Communication  on support  for  private sector development. 

6 The appraisal  of these issues is taken up in section 4.3.2.1. 

10 

There  are  several  elements  in  a  favourable  environment,  as  discussed  in  the  following 
sections. 

4.2.1  Macroeconomic policy 

The  informal  sector  has  generally  has  experienced  the  fastest  growth  in  less  developed 
countries,  and  is  especially  important  for  creating  jobs.  There  are  many  constraints  to  the 
growth  of  individual  small  and  microenterprises,  including  credit  constraints,  and  the 
sustainability  of  these  small  and  microenterprises  is  also  a  major  concern.  Although 
microfinance  can  help  to  resolve  these  credit  constraints,  inappropriate  macroeconomic 
policies  can  result  in  conditions  which  hinder  microfinance  development  (e.g.  high  interest 
rates).  Macroeconomic policy should generally encourage private  sector developments  as the 
vehicle  for  achieving  equitable  economic  growth. 
It  should  help  promote  a  climate 
favourable  to savings and investment at all levels and the development of microenterprises 

At present  the  level  of transactions  in microfinance  is small, but growing, compared  with  the 
level  in  national  economies  as  a  whole.  It  would  therefore  be  rather  early  (in  1998)  to  be 
overcautious about the development of the microfinance  sector and its potential  effects  on the 
management of the macroeconomy. 

4.2.2  Financial Sector 
There  should  be  particular  attention  to  the  financial  system.  The  following  issues  should  be 
assessed, and where appropriate, introduced  into policy dialogue with governments by  donors 
with interests in  microfinance. 

4.2.2.1  Preconditions of donor support 

Donors  need  to  establish  the  minimum  acceptable  criteria  for  support.  Before  becoming 
involved in microfinance  development  operations, donors should expect to find the  following 
conditions exist within the financial sector: 

Institutions  are  allowed  to  charge  interest  rates  which  cover  the  full  cost  of 
operations7 

Legislation  can  be  adapted  to  facilitate  microfinance  operations.  For  instance, 
financial  institutions  should be  allowed  to develop  savings  and to  diversify  their 
operations into other fields  such as leasing or risk capital 

There  should be a regulatory  framework  setting  out the  rights  and obligations  of 
microfinance  institutions to ensure that markets operate competitively.8 

The  EU  should  only  provide  support  when  these  preconditions  have  been  met,  and  when 
governments express a strong commitment to continue policy reforms. 

There  are  particular  difficulties  with  conditionality  when  there  is  a  need  for  a  long  term 
partnership  for  institutional  development.  Many  events  can undermine  governments  ability 
to carry  out policy  reforms  that  will promote  the  steady  development  of  the  sector.  Donors 
have to exercise judgment  whether the policy changes will  adversely affect  the sector,  and,  if 
so, when  the policy  reforms  can be  continued.9  Abandoning  what  has been  planned  to  be  a 

7 This includes not only the costs of providing the services directly to the clients, but also the indirect costs of 

recruiting and training staff, monitoring perfomance, developing the business, and management etc. 

8 Improving the operation  of this framework  in practice can be a focus for technical  assistance. 

9 The mechanistic application  of penalties when conditions have not been met should  be avoided  if the aim is to 

establish a long term partnership. 

11 

long  term  commitment,  though,  is  a  last  resort  if  it  becomes  clear  that  a  government  has 
effectively  renged on its commitment to the reform process. 

4.2.2.2  Links to commercial financial services. 

Until  recently,  banks  and  commercial  financial  services  have  not  usually  been  interested  in 
small  savings  and credit  operations.10  This  lack  of  interest  has provided  a constraint  on the 
extent  to  which  microfinance  institutions  could  grow.  They  were  unable  to  access 
commercial  loans or equity investments. 

There are several reasons for the lack of interest of the commercial sector in these institutions. 
Often  the  scale  of  operations  was  too  small  to  offer  an  attractive  investment  opportunity. 
Returns were  likely  to be  small  and  risky.  Moreover  the operations  of  the institutions  were 
not transparent, since financial reporting systems were underdeveloped. 

Financial  sector  reforms  should  seek  to  reduce  transactions  costs  and  other  constraints  on 
microfinance,  by  bringing financial services  closer to  the  people,  and encouraging  linkages 
between the microfinance  institutions and the banking system. 

4.2.2.3  Regulatory environment 

The regulatory environment should encourage microfinance  institutions to start and grow. For 
example, in countries where there are restrictions on the setting up of savings societies, these 
should be reformed.  In countries where there are restrictions on the level  of interest charged, 
which undermine  the potential  sustainability  of the microfinance  institutions, there should be 
reform consistent with the encouragement of microfinance. 

These reforms  of the regulatory  environment need to avoid potential  negative  consequences. 
The regulations  should ensure that microfinance  institutions are managed according to sound 
financial  practice. In particular, reforms  should retain a concern to protect savers from fraud. 
There  needs  to be  a monitoring  system  which provides  for  constant  vigilance regarding the 
effects  of the regulations. 

4.2.2.4  Donor support 

There  is  clearly  a role  for  donor  support  in the  development  of  the  financial  sector,  to take 
account of the needs of microfinance,  especially at the early and middle stages of institutional 
development. 

The aim  is  to  create  a development  partnership between  donor and microfinance  institution. 
Support should be given to the institutional development of microfinance  institutions. 

Strengthening  financial  audit  arrangements  is  an  immediate  need  for  technical  assistance. 
Longer  term  aims  might  be  to  develop  other  forms  of  audit.  Given  that  microfmance  is 
intended  to  reach  the  poor,  the  skills  of  social  audit  would  be  needed  to  see  if  the 
microfmance  institutions are meeting the objectives  of their primary clients. 

However,  many  observers  have  cautioned  against  the  rapid  deployment  of  substantial  donor 
funds  within  the  microfinance  sector.  The  dependence  of  microfmance  institutions  on  grant 
support  can  undermine  effective  financial  management  and  act  against  the  development  of 
enfrepreneurship,  which  is  the  essence  of  private  sector  development,  and  undermine 
prospects for  sustainability. More established microfmance  institutions will eventually  replace 
donor support with commercial loans. 

10 There have been  some exceptions, for  instance BRI in Indonesia.  In another case, discussed  in an internet 

forum  in late  1997, the Bank's  interest appeared to be for publicity purposes  only. 

12 

4.2.3  Good governance and microenterprise 
Urban  management policies should be encouraging  to microenterprises, not imposing  various 
petty restrictions  on the economic opportunities of the poor.  For example,  in less  developed 
countries,  it  is  unfortunately  common  to  see  local  officials  and  police  harrassing  petty 
commodity  traders. The promotion  of microfinance  requires  action  to reduce  the numbers  of 
petty urban regulations and to fight such corruption. 

Rural  development  policies  should  encourage  the  development  of  agro-based  small 
enterprises.  This  can  be  done  in  various  ways,  such  as  improving  market  intelligence  and 
access to inputs. 

4.2.4  Removing Gender Biases 

Women's  activities  are  often  the  source  of  growth  in  the  agricultural  micro-enterprise  and 
microfinance  fields  but  there  are  several  aspects  of  policy  that  restrict  women's  access  to 
financial  services,  and  therefore  limit  the  growth  of  their  businesses.  For  instance,  the 
provision  of  collateral  is  constrained  when  women  are  not  able  to  own  land.  The  rules  of 
inheritance  may  be  a disincentive  for  women  to  accumulate  capital.  Women  may  need  the 
endorsement  of men in the household to take a loan. 1 * 

Removing  these  gender  biases  in  policy  would  help  to  encourage  the  development  of 
microfinance. 

4.3  Working with Microfinance Institutions: 

When working with microfinance  institutions, donors should try to help them grow and 
become sustainable  in the long term.  The path that has emerged involves: 12 

attention to identification  and detailed  appraisal of the potential  of the  institution, 
taking account of present capacity and vision 

institutional  development  support  at  the  beginning 
institutions 

to  help  establish 

the 

further  support later to strengthen links with commercial  sources of  funds 

Such  a path  for  donor  support  does not  fit  neatly  into  the normal  3 year  project  framework, 
and  involves  a  commitment  to  enter  into  partnership  for  at  least  7  to  10  years.  Such  a 
partnership  imposes  specific  requirements  on  donors  to  calculate  and  take  acceptable  risks 
during  appraisal  and  establish  monitoring  systems  which  encourage  joint  learning  from 
experience.  This  approach  has  put  great  emphasis  on  the  need  to  learn  lessons,  and  to 
develop and apply principles of good practice, 

These points are set out below in relation to the project cycle. 

4.3.1 

Identification 

To obtain the support of the EU, the wider objectives  of  microfinance  institutions we  support 
should  be  in  line  with  EU  economic  and  social  policy  objectives:  to  reduce  poverty  by 
facilitating  the take up by the poor of sustainable economic opportunities. These  opportunities 
involve  production  of  goods  and  services  that  rely  on  local  inputs  and  readily  accessible 
markets. 

'  1  See section 3.5 for a fuller  treatment of gender issues. 

' 2  A  precursor for working with the institutions is analysis of the policy framework.  This has been  discussed 

above in section 4.2. 

13 

Many microfinance  institutions have a social  orientation  to reach the poor and have  adopted 
the microfinance  mechanism as an appropriate one for reducing poverty. The specific  aim  of 
the  microfinance  institution  is  to  offer  flexible  financial  instruments,  not  usually  available 
from  commercial banks, to greater numbers of the poor to meet local needs. 

Although  many  microfinance  institutions  will  fulfil  these  general  criteria,  the  EU  donor 
agencies should take care over their selection of microfinance institution. 

The EU should use the following selection criteria:^ 

vision (clear development strategy, focus on generating local  savings) 

institutional  strengths  (sound  governance,  free  from  political 
institution, 
existing 
information systems and good reporting standards); 

interference, 
institutional  capacity,  accurate  management 

licensed 

quality  of  services  for  the  poor  (focus  on  the  poor  and  increasing  outreach, 
appropriate and flexible lending, savings services); 

financial  performance  (appropriate  pricing,  portfolio  quality,  reduction  of 
dependence  on  donors,  and  capacity  to  mobilise  commercial  funds  to  reach 
independence). 

openness to advice (acceptance of need for change, ready to engage in dialogue). 

4.3.2  Appraisal 

Many institutions  are unlikely  to become viable in the long term.  There is a wide variety  of 
conditions  in less  developed  countries  which constrain  the viability  and sustainability  of the 
institutions. 

4.3.2.1  External factors 

Since the development of a microfinance  institution is a fairly lengthy process  it can easily be 
disrupted.  Some  attention  should  be  given  to  assessing  the  external  risks  to  the  Institution, 
such as: 

natural  events  of  predictable  frequency  and  severity  which  impact  on  the 
community at large e.g. droughts, floods, cyclones, earthquakes 

illness  and  epidemics  which  have  severe  impact  but  be  unequally  distributed 
among households e.g. HIV/AIDS; some such illnesses may be seasonal 

civil  conflict 

Risks  also  include  changes  in  the  policy  environment,  possibly  following  a  change  of 
government.  These issues have been dealt with above. 

All  these possible  events  can  have  impact  on the  sustainability  of microfinance  systems  and 
need to be  integrated  into planning  as many risks have a predictable  frequency.  There would 
be differences  in dealing with those risks which develop slowly  (e.g. drought or civil  conflict) 
and those which are more sudden (e.g. earthquake).  In assessing the risks, care would need to 
be taken over calculating the severity of the potential  impact on the microfinance  institution. 

This list  draws on criteria  established  by multi-donor  networks, especially the Committee  of Donor A^cnci 
Per Sim!! Enterprise- Development  and  Donors''  Working Group or  Financial  Sector  Development  Micro £ 

oorïïng  srr.arift! 

The practical consequences  for the microfinance  sector may include: 

setting cost recovery charges at a level that reflects  such known risks 

diversification  of the microfinance  institution's  portfolio 

development of affordable  insurance services. 

4.3.2.2  Internal  factors 

The  aim  of the  institutional  appraisal  is to establish  whether  the appraisal  team  believes  "the 
Microfinance  Institution  will  develop  into  an  institution  which  can  expand  independently  of 
further  donor  resources, reaching  massive  numbers  of very  poor  clients  with  funding  that  is 
predominantly  commercial."  The team must consider the extent to which the MFI's vision  is 
focused  in this direction. 

To reach  this judgement,  the team must assess the  financial  and non-financial  factors  bearing 
on the ability  to reach  independence,  the operating changes required,  and other hurdles to be 
overcome. 

Overall  the  appraisal^  covers  a  whole  set  of  institutional  factors,  services  and  market, 
strategic  objectives,  and  financial  performance.  From  these  it  is  possible  to  set  out  the 
essential  elements  (see  box  below)  in  appraising  whether  to  accept  or  reject  support  to  the 
microfinance  institution. 

Essential appraisal  elements 

Location 

Other Donors' experience 

Leadership 

Financial Manager 

Strategic Financial Planning 

Income Statement and Balance Sheet 

Profitability 

Voluntary Deposit Service Analysis 

There  is  a  danger  in  setting  out  the  principles  of  good  practice  in  appraisal  that  donor 
agencies will  apply  the most  rigorous  standards in a mechanical  way, not paying  attention  to 
the real  conditions  in society and the informed judgement  of the microfinance  institution.  In 
practice, donors are  looking  to  support  the development  of better  standards  during  a  process 
of institutional  development. 

4.3.3 

Implementation:  Start  Ups 

Where a microfinance  institution does not exist, there are difficult  decisions  about whether  to 
start them or leave the area. 

14 In assessing the factors within the Microfinance  Institution, this section draws on guidance 
presented in the Format for Appraisal of Microfinance  Institutions (Secretariat of the 
Consultative Group to Assist the Poorest,  February 25, 1997). 

15 

Some donors have experimented  in startups. There are several profound  and critical  dilemmas 
to resolve, but  there  is  little understanding  of  the  conditions  for  success  and  failure.  Donors 
which have skilled technical assistance to deploy might consider this option. 

These activities do not necessarily require large  funds. 

In the circumstances, the EC will not become involved in this area. 

4.3.4  Implementation: Establishment 
Much  of  the  advice  about  microfinance  institutions  comes  from  detailed  assessments  of 
established microfinance  institutions. 

Supporting  the growth of established  institutions  is a less risky option  than  start-ups, but  still 
requires donors with  strong  technical  assistance  in traditional  areas of business  management. 
During  the  implentation  stage,  the  donor  gives  support  to  build  up  the  technical  capacity, 
product portfolio  and client base of the selected institution.  This can be done by  using  capital 
grants  for  buildings  and  equipment,  and  technical  assistance  to  strengthen  financial 
management  information  systems. ^  At a later stage, loans and equity financing can be used 
to support the growth of the institutions. 

It  is  likely  that  most  donor  agencies  will  wish  to  develop  support  to  MFIs  in  this  stage  of 
development.  This  will  help  with  their  own  development  of  institutional  capacity  to  offer 
support to the microfinance  sector. 

4.3.5 

Implementation:  Integration  into Commercial  Systems 

Donors  should  help Microfinance  Institutions  integrate  into commercial  lending  systems  and 
capital markets. Different  mechanisms can be proposed and special forms of support are  often 
needed.  Funding  may  be  needed  to  help  leverage  private  sources  of  capital  or  to  provide 
guarantees for commercial bank loans. 

The  two  most  commonly  tried  have been  through  the provision  of  Guarantee  Funds  and  the 
development  of  Apex  Organisations.  Specialist  technical  assistance  should  support  such 
activities. 

4.3.5.1  Guarantee  Funds 

There  have  been  several  attempts  by  donors  to  provide  guarantee  funds  to  encourage 
investors  to  take  risks  and  to  induce  them  to  become  involved  in  lending  to  microfinance 
institutions.  Many  of  these  attempts  have  failed  because  the  donor  funding  has  undermined 
financial  discipline  in  the  system.  More  recent  attempts  to  introduce  guarantees  distribute 
risks to all the stakeholders to correct for this problem. 

There  has  been  some  recent  professional  scepticism  about  the  "sustainability"  and 
"additionality"  of  guarantee  funds. 16 The  cost  of  providing  the  guarantees  also  adds  to  the 
costs  of  the  microfinancial  services,  making  it  more  difficult  for  the  institutions  to  become 
sustainable in the long run. 17 

1 5  Some donors also argue that support can even be given to the operating  costs, but  this  must be  for  a 

strictly  limited  period  (usually  2 to  3 years).  This  is an  area  of  some  debate. 

16 For example, recent discussion  in an internet forum  on development  finance.  The discussion  highlighted  both 

problems and possible solutions. 

17 This point was made strongly  by the Austrian  representative in the Expert Group meeting in  1997, and 

reiterated  in the Council  working group on development  cooperation. 

16 

There  are  possible  solutions  to  these  problems  but  more  study  and  reflection  is required  on 
guarantee  funds,  and the alternatives, before  they are acceptable  instruments  for  major  donor 
support. On this issue, the EU should  continue to collaborate  with the  Consultative  Group  to 
Assist the Poorest in its learning activities. 

4.3.5.2  Apex Organisations 

Most Apex 18 organisations are best considered  facilitators  of the growth  of the  microfinance 
industry, rather than a formal  system of financial intermediation in the banking  sector. 

The perceived  need  for  these  organisations  arises  as the number  of microfinance  institutions 
increase  and practitioners  see the potential benefits  of an organisation  that  can provide  a link 
to the formal  sector and a number of common services (e.g. staff training). 

The development  of these facilitating  organisations poses problems of a different  nature  from 
traditional  MFIs.  While  there  is  a  need  for  funding  to  help  leverage  commercial  sources, 
there are also problems that require skilled technical  assistance. 

At  present  there  are  few  such  organisations  so  information  about  their  functioning  and 
success  is  limited.  Further  research  is  needed  on  these  organisations  before  they  can  be  a 
recognised area of EU support. 19 

4.3.6 

Implementation:  Monitoring  performance 

EU  donors  provide  funds  for  loan  capital  and  capacity  building.  The  intention  to  reinforce 
the institutions and sustain their operations requires adherence to certain recognised  principles 
of  good  practice  in  the  design  of  assistance  as  discussed  in  relation  to  appraisal.20  During 
monitoring  of microfinance  institutions, particular  attention  should  be  given  to the  following 
key issues: 

search  for  self  sufficiency  -  for  instance  through  progressive  reduction  of  grants  and 
move towards commercial finance 

good governance - accountability to the poor and consistency with financial  safeguards 

transparent reporting - to encourage investment by commercial partners 

good financial management - to encourage the reduction of costs of services 

interest rates charged by the microfinance  institution should cover the costs of operations 
and  changes  should  be  governed  by  the  market  not  by  political  interference  on  the 
governing Board 

targeting  of financial  resources - for  instance, to support  institutional  development, but 
not to subsidise interest rates 

savings services should be encouraged  from  the beginning, rather  than  focusing  on the 
provision of credit 

a professional approach to loan appraisal and monitoring 

support the information networks that support microfinance institutions 

18  An Apex  organisation  provides common  services for a group of participating microfinance  institutions, and is 

funded  primarily by contributions from  these institutions. 

19  This is another area where participation  in the CGAP learning activities is important. 

20  This section draws on the CGAP appraisal  format. 

17 

4.3.7  Evaluating  Impact 

An  important  area of activity  for  the the microfinance  institutions  and  donors is  the 
evaluation  of impact.  There are several  dimensions that  should  ideally be  considered 
in the  evaluation: 

0  Poverty orientation: To what extent does the MFI reaches the poor?  What types of poor 

are reached?^ 1  Are there any unanticipated consequences of targeting? 

0  Income effects:  To what extent do the activities supported raise the incomes of the 

members? Are these income effects  sustainable? Could more be expected? 

0  Social effects:  To what extent have the institutions contributed to the empowerment  of the 

poor in other areas?  Has there been an increase in organisational  capacity? 
0  Growth of the institution: What has been the coverage of the population and the 

microfinance  services?  What would be a reasonable expectation of growth in  future? 

0  Environmental  effects:  To what extent have the enterprises supported through the 

microfinance  institutions been beneficial  or detrimental to the physical environment? Are 
the enterprises  sustainable? 

The intention of such an evaluation is to feed back the results to achieve better targeting of 
operations, better advice to microfinance  clients, and to enhanced the contribution  of 
microfinance  to development processes. 

4.4  Common standards of donor support 

4.4.1  Donor  funding:  a careful  approach 

The  European  Commission  can  use  several  financial  and  non-financial  mechanisms  to 
support the microfinance  sector: the provision  of capital, credit  guarantee  schemes, supply  of 
credit  in  kind,  equity  financing,  and  institutional  support.  Other  donors  have  a  similar 
portfolio  of mechanisms.  The issue arises which to deploy for best advantage in this field. 

There  is  no  doubt  about  the  great  demand  for  microfinance  services,  but  it  is  advisable  to 
sound a note  of caution  about the capacity  of microfinance  to absorb  substantial  donor  funds 
at  the  present  time.  Despite  the  pressure  of  some  institutions  themselves,  CGAP  believes 
there  are  already  too  many  funds  chasing  too  few  viable  institutions.  It  is  necessary  to 
develop a strategy  for providing support according to the demand. It is generally accepted that 
capital  is  not  the  main  constraint  on  the  formal  sector  institutions  becoming  involved  in 
microfinance, but rather the lack of infrastructure  (both financial and other kinds) to allow the 
funds  to be delivered effectively  to low income groups.  The emphasis, therefore, has to be on 
the  careful  establishment  of  the  sector  and  growing  more  viable  institutions  with  healthy 
savings, which can over time absorb more funds from commercial  sources. 

A certain  amount  of confusion  has  surrounded  the effects  of the  instruments  of  assistance  to 
the  sector.  On  the  one  hand,  there  is  general  agreement  that  a  subsidy  (e.g.  a  grant  to  the 
capacity  building  of the  institution,  or  guarantee  funds)  might be required  at different  stages 
in the life cycle of a microfinance  institution to establish it and help it to grow.  On the other 
hand, there is now general  acceptance that other  subsidies  (e.g. to interest rates) which would 
be unsustainable in the long term, should be avoided. 

The  approach  to  microfinance  of  supporting  institutions  and  developing  the  microfinance 
sector has brought to attention the need  for common  standards among donors.  Without these, 
coherent  development  of the sector would be adversely  affected.  It has taken time for  donors 
•o  agree  the  common  standards.  The  Committee  of  Donor  Agencies  for  Small  Enterprise 

The information  here should  be disaggregated  by gender. 

18 

Development,  and Donors' Working Group on Financial  Sector Development produced  a set 
of Guiding Principles in October  1995. 

The EU should adopt these common standards, and work with others to develop the  standards 
in innovative areas. 

4.4.2  Strategies  for Donor  Support 

The  EU  should  follow  the  Guiding  Principles  regarding  the  strategies  for  donor  support  as 
follows: 

Grants  for  institutional  development  are  appropriate  at  different  stages.  At  start 
up,  grants  can  support  the  costs  of  establishing  the  institution  -  premises, 
equipment, staff training, technical  assistance.  Later they can be used to help the 
institutions join the formal  sector. 

Grants for capitalisation.  This can help generate domestic mobilisation of  funds. 

While,  in general,  it  is preferable  to  avoid  covering  operating  costs,  in  practice, 
this can be  done  for  limited  start  up period.  This  might  be  3 years,  and  should 
certainly not exceed 7 years. 

Loans  are  used  by  institutions  that  have  reached  a  certain  level  of  operation. 
They  might  support  the  move  to  full  commercial  operations.  This  transition 
might be supported by the creation of guarantee  funds. 

Many  committed  microfinance  institutions  try  to develop  even  better  practice.  For  instance, 
they may attempt to develop alternative financial  services to reach the poorest, while adhering 
to  the  basic  principles.  The  EU  can  provide  funding  and  technical  assistance  to  help  with 
these learning processes. 

Different  options  for  support  may  arise  at  different  stages  of  development  of the  institution, 
so managing transitions from  one kind of support to another is important. 

In addition  to the above  common  strategies  for  donor  support  to the  financial  sector,  the  EU 
might  give  technical  assistance  to help  with  adapting  legislation,  or  engage  (alongside  other 
donors)  in  policy  dialogue  regarding  the  macroeconomic  framework  and  financial  sector 
reform  to allow diversification  of financial  instruments. 

Several  detailed  lessons about  sustainability  have emerged  from  evaluation  and  other  studies 
of past credit operations.  There is now a growing consensus about the previous practices that 
undermined  sustainablility.  These  practices  and  the  results  are  shown  in  the  table.  They 
should be avoided. 

Rapid depletion of funds 

Subsidised  interest rates 
Focus  on  credit,  without  generating  Programmes 
savings 
Non-financial  services offered 
Small number of borrowers 
Lack of financial  discipline 
Inadequate  attention  to  financial  skills  Loans poorly  managed 
of staff 
Systems planned in centre 

external  sources of  funds 
Very costly programmes 
Costs not covered by  revenue 
Poor loan repayment  record 

Not fit local practices 

dependent 

I 
on  i 

19 

5.  Donor coordination 
It  is  useful  to  consider  the  various  roles  that  can  be  played  in  the  development  of  the 
microfinance  sector.  Given the different  capacities and institutional  arrangements of Member 
States  and  European  Commission  Directorates  General,  each  of  the  European  Union 
development  agencies should carefully  consider its own comparative  advantage. 

The  Council  Resolution  draws  attention  to  the  need  to  consider  coordination  at  different 
levels. 

5.1 

International level 

The  main  existing  network  for  coordination  of  policy  and  practice  on  microfinance  is  the 
Consultative  Group  to  Assist  the  Poorest  (CGAP).  Its  overall  objective  is  to  further  the 
development  of  microfinance  services  for  very  poor  clients. 
It  does  this  by  facilitating 
learning  about  successful  approaches  to  microfinance  and  helping  to  strengthen  donor 
agencies' own operations.  Since it was launched in  1995, the CGAP Secretariat has produced 
several documents setting out ideas of good practice in this field. 

CGAP, up to the present, has focused  on the issue of financial sustainability  .  There  is also a 
need to consider other policy objectives. For instance, many  small businesses have an impact, 
often  adverse,  on  the  environment.  Although  it  is  unlikely  that  environmental  monitoring 
would be done by microfinance  institutions themselves, consideration  should be given to how 
this might be done. 

The  EC  and  Member  States  active  in  the  field  of  microfinance  should  actively  support  the 
development  of  CGAP,  and  any  follow  up  network  of  donors.  This  will  require  funding 
support  for  the  work  of  the  Secretariat,  and  active  participation  in  the  learning  and 
dissemination  activities.  EU members  should  share  information  from  their  own  evaluations. 
It  would  be  useful  to present  the results  of operations  and  assess  the  socio-economic  impact 
of the different  assistance programmes on the target populations. 

5.2  European Union: Community and Member States 

There  is  a need  for  EU  donors  to  agree  to  coherent  policies.  There  have  been  situations  in 
which  different  members  of  the  EU  have  pursued  different  policies,  or  the  same  donor  has 
followed  incompatible  policies  in  different  parts  of  the  sector.  Such  confusion  undermines 
the development  of microfinance  and reduces the  impact  on development.  So there  is a clear 
need  to agree on financial sector policies within  a country,  appropriate  interest rates given  to 
particular institutions, and other terms for assisting the sector. 

In  the  case  of  the  members  of  the  EU,  the  present  Communication  and  Council  Resolution 
provides  the  basis  for  such  a common  policy,  and  should  be  integrated  into  bilateral  policy 
statements. 

In  this  fast  moving  field,  policy  formulation  has  to  respond  to  further  developments  in  our 
common  understanding,  perhaps  resulting  from  lessons  learned  in  the  international  forum  or 
from  our  bilateral  experience  and  research.  The  EC  should  therefore  call  together  a 
Microfinance  Expert  Group  of  Member  States  to  discuss  the  emerging  issues  on  an  annual 
basis, and to consider amendments to the EU policy framework. 

Implementation  of  a  policy  on  microfinance  will  depend  on  concerted  efforts  by  staff  arid 
consultants.  There might be coordination in their training. 

20 

5.3  Country level 

The EU has an interest  in supporting microfinance  institutions to become  sustainable, but this 
can  be  undermined  by  competition  among  donors  at  the  country  level.  Operations  of  some 
donors  may  be  seen  as  undermining  the  operations  of  another.  Governments  have  an 
important  role  in  coordinating  the  activities  of  donors  in  the  microfinance  field.  Donors 
should also share information  about planned operations. 

Microfinance  institutions  often  make  applications  to different  donors.  It  would  be  helpful  to 
use  others'  appraisals  of  microfinance  institutions,  as  suggested  in  the  CGAP Format  for 
Appraisals.  There  are  also  possibilities  for  better  coordination  in  monitoring,  management 
information  systems, performance  standards and reporting arrangements. 

The government  of the concerned  country  should  be involved  in discussions.  In many  cases 
there  is  a lack  of  governmental  capacity  in this  field  which  constrains  the  development  of  a 
conducive  policy  framework,  regulatory  environment,  and  supervision.  Donors  can 
coordinate their efforts  to support the necessary institutional  development. 

21 

ISSN 0254-1475 

COM(98) 527 final 

DOCUMENTS 

EN 

11  05  01  16 

Catalogue number  :  CB-CO-98-549-EN-C 

ISBN  92-78-39442-4 

Office  for Official  Publications of the European  Communities 

L-2985 Luxembourg