“The Next Stage of Financial Inclusion;” by D. Karlan; published by the Stanford Social Innovation Review; fall 2014; 9 pages; available at: http://www.ssireview.org/pdf/Fall_2014_The_Next_Stage_of_Financial_Inclusion_1.pdf
This paper investigates the evolving role of nonprofit organizations in providing microcredit to people with low incomes. Dr Karlan argues that the role of nonprofit organizations has changed from providing microcredit to people with low incomes in general as for-profit companies have entered the market and begun to provide these services effectively. Instead, nonprofit institutions are addressing market failures to reach those who continue to be excluded from the market. The article is structured around three issues: (1) reaching individuals not covered by the for-profit sector, including those “too rural,” “too poor” or “too young;” (2) building trust among customers and microcredit providers; and (3) promoting innovation.
The author argues that pursuing poor people living in very rural areas is expensive and in fact unsustainable on a for-profit basis. He suggests that nonprofit organizations should promote savings-led microfinance, such as savings groups in which 10 to 30 people work together to save and loan to each other. Randomized trials conducted in Ghana, Malawi, Mali and Uganda by Innovation for Poverty Action (IPA), with the help of Plan International, Oxfam and Freedom from Hunger (FFH) indicate that savings groups initiatives have a modest, but positive impact on total savings, livestock levels and higher levels of food security.
Dr Karlan further argues that nonprofit institutions are essential to strengthen trust between the financial industry and its future customers, and that they are vital in ensuring a smooth transition for the emergence of for-profit companies. A recent study conducted by IPA in Uganda showed that certain products previously unknown to the public had a purchase rate of 49 percent if sold by nonprofit vendors compared with 31 percent if sold by for-profit vendors. Endorsement or certifications by microfinance institutions (MFIs) can also lead to higher purchase rates. BASIX, an India-based MFI, demonstrated in one instance that the purchase rate for rainfall insurance was 36 percent higher when an MFI-endorsed insurance educator promoted it.
As financial returns of process innovation in the microfinance sector are very low, Dr Karlan argues that nonprofit institutions should be the key agents promoting innovation. The first policy proposed is to replace debt financing by equity financing, as is common in Islamic finance models, such as ijarah, murabaha or musharaka. The second proposed measure is to provide more generous repayment schedules using concepts from corporate project financing. For instance, a company that borrowed money to build a factory would only have to repay its loan once the factory starts generating revenues. A study conducted in India demonstrated that test groups with a grace period of two months had a 4.5 percent likelihood of starting a business compared to 2 percent for control groups that had a two-week grace period. It further showed that after three years, business profits and household incomes were 41 percent and 19.5 percent higher for the group with the longer grace period. However, the study also demonstrated that default rates were up to 6.2 percent for the test group compared with 1.7 percent for the control group.
By Simon Pfanner, Research Associate
 Standard Social Innovation Review, “The Next Stage of Financial Inclusion“
MicroCapital, July 12, 2012, Innovations for Poverty Action (IPA), Citi Foundation Issue Call for Financial Capability Research Funding Proposals
MicroCapital, November 9, 2010, Microfinance Bank Compartamos Banco, Researchers Dean Karlan of Yale University and Jonathan Zinman of Dartmouth University to Study How Customers Use Microfinance Products
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