PAPER WRAP-UP: “Community-Managed Loan Funds: Which Ones Work?” by Jessica Murray and Richard Rosenberg

Written by Jessica Murray and Richard Rosenberg, published in May 2006 as Focus Note Number 36 by the Consultative Group to Assist the Poor (CGAP), 15 pages, full text available at: http://www.cgap.org/gm/document-1.9.2577/FocusNote_36.pdf

Community-managed loan funds (CMLFs) are small-scale credit funds made up of generally five to 40 members (p3) that are managed by the members themselves, with no professional supervision of the approval, disbursement, and collection processes of loans. Such programs often exist in niches that are costly to reach for professionally-managed microfinance institutions (MFIs), such as remote or sparsely populated areas (p3), or areas of conflict (p5). About 30 percent (p4) of microcredit projects funded by the World Bank and the United Nations Development Programme (UNDP) use a CMLF model. The paper roughly estimates the total global funding of CMLF projects to be over USD 200 million (p4) per year.

Performance evaluation reports pertaining to 60 CMLF projects (p2) between 1990 and 2005 are used to determine which models are most successful. The primary performance criterion used to judge success was repayment rate (p2). The authors argue that the principle factor determining the success of a CMLF is the source of funding (p1) for the loans. They divide CMLFs into three categories (p1) corresponding to this factor.

1) Externally-funded groups (p5-6) – The program is funded right from its nascent stages by external funds from donors or governments, sometimes without collecting savings at all. Of 20 externally funded groups in the study, the majority reported repayment rates of below 70 percent (p7), and only one was judged successful (p5). The authors argue that the high default rate is caused by a lack of social reinforcement of payment as the loans are viewed as outsiders’ money (p6) rather than that of a neighbor. They propose externally-funded groups should be abandoned (p6) as a form of poor people’s finance.

2) Savings-based groups (p6-8) – Loans are financed by members’ own savings. Each of the 11 savings-based CMLFs in the study reported repayment rates of over 95 percent (p7), and all were judged successful. The authors state that when members provide the funds, the incentives favor more careful management of the money. Rather than finance loans, any external support (p7) goes towards organizing groups, training members how to operate the fund, and helping set-up appropriate record keeping systems. Despite the success, external support of savings-based groups has been limited (p7), possibly due to the limited amount of money it is possible to transfer into the community in this manner.

3) Self-help groups (SHGs) (p8-10) – SHGs allow poor members to access bank services as a single unit. The programs begin by collecting and lending members’ own savings, and once a proven track record has been developed, they receive larger loans from a banks that are serious about collection. Most SHGs exist in India (p8) where the government sanctioned banks to extend of financial services to the poor. Although specific information is not provided on the performance of SHGs, the paper reports that performance has been mixed, and it appears there is an opportunity for a financially viable model (p9). Seeing this opportunity some banks have begun surpassing their lending quota (p9).

The authors question (p11) whether development agencies should have a general preference between CMLFs and MFIs in areas where either of the two models could be viable. They note CMLFs provide certain advantages (p4-5): lower internal transaction costs as they avoid the cost of personnel, offices, transport, etc.; more flexibility in loan repayment schedules, because they are made up of few members who often know each other; and the ability to take on community based development projects and offer non-financial services such as health and human rights education. Perhaps most importantly, because they are informal, CMLFs are not bound by the same regulations as MFIs, and can offer savings (p5), which many MFIs cannot.

However, because CMLFs lack professional management it is more difficult to institutionalize good record keeping, monitoring, and sound financial management, and thus are generally less stable (p12) than MFIs. Also, CMLFs cannot provide the range of services of MFIs such as varied loan products and cash transfer services. The authors state that more research (p11) is needed to determine the optimal model.

By Ryan Hogarth, Research Assistant

Additional Resources:

“Community-Managed Loan Funds: Which Ones Work?” by Jessica Murray and Richard Rosenberg, published by the Consultative Group to Assist the Poor (CGAP): May, 2006

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