MicroStart: A Guide for Planning, Starting and Managing a Microfinance Programme.

INTRODUCTION
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D. SUCCESSFUL MICROFINANCE

1. Common Myths and Realities
2. Lessons - Why Do Projects Fail?
3. What Works

(1) Common Myths and Realities

The work of Grameen Bank, Banco Sol, Bank Rakyat Indonesia, and others reflects some of the breakthroughs in small-scale credit delivery emerging over the past few years. However, many credit programmes do not rise to the level of success of these institutions because of common misconceptions concerning the limitations of the poor and their economic activities.

The following are common myths among many poorly performing microfinance programmes:

MYTH REALITY
Microentrepreneurs need to be cared for because they are poor, Microentrepreneurs are knowledgeable about doing business in their local economy. They often have years of experience in their trade working with dedication and determination. Belief in the intelligence and business knowledge of clients is critical.
Microenterprises are redundant activities that should be replaced by larger businesses employing many people. While often marginal, microenterprises are viable, locally important activities that should be upgraded. These smallscale economic activities are valid business activities to be taken seriously.
Interest rates to the poor need to be subsidized. Microfinance rates of interest must reflect operating costs to achieve sustainability. Organizations making large numbers of small loans will have high transaction costs and thus need to charge rates that are higher than commercial rates. However, microfinance rates are still significantly lower than the exorbitant rates charged by money lenders and other sources from whom the poor borrow.
Credit alone is useless. It must be packaged with training, marketing, technology, and other services. Although programmes which package credit with other services may seem ideal, they require large subsidies and have proven to be largely unsustainable. The minimalist approach used by the Grameen Bank and many others has shown that clients can use credit in small amounts to start or improve the profitability of their microenterprises. Providing marketing and many other areas of services is valid, but best managed separately.
The poor cannot be trusted with credit. The consumption needs of the poor are so pressing that any loan will find its way quickly to consumption. The high repayment rate of millions of microfinance clients is empirical proof that the poor are credit-worthy.
The poor are unable to save. The high rate of savings reported by many microfinance organizations demonstrates that the poor can value savings as much as credit.
Poverty has a crippling effect rendering the poor unable to improve their condition. The remarkable success of institutions lending to over 10 million clients around the world, the vast majority of whom are below the official poverty line (usually defined by caloric intake), proves beyond any doubt the ability of the poor to improve their lives with their own ingenuity and drive.
(2) Lessons - Why Do Projects Fail?

MicroStart is based on some 20 years experience of microfinance practitioners worldwide. Results from many countries demonstrate that very small-scale farmers, traders, and artisans living in rural and urban areas can put small loans to good use. Extending small amounts of credit, along with appropriate encouragement and orientation leads to significant increases in income, production, and employment. The best projects combine quick access to credit with skilled financial management.

While there is a significant and growing number of successful organizations, many attempts have left a legacy of doomed enterprises supported by endless subsidies. High default rates, unsustainable administrative costs, and long delays in the delivery of services are some of the pitfalls which must be avoided. Projects have failed for a number of reasons.

FINANCIAL INSTITUTIONS

When microfinance efforts are run by banks or financial institutions, they often:

create obstacles such as legal registration, personal guarantees, property title, and collateral requirements that effectively bar most potential clients;

intimidate poor people, many of whom have never spoken to a bank officer or entered a bank;

are expensive for the poor because of excessive documentation, repeated visits to the institution, and endless waiting for loans;

provide credit ill-suited to the needs of the poor- too much credit extended for too long.

SOCIAL SERVICE AGENCIES

When programmes are run by social service agencies, they often engender another set of problems. Typically:

Staff have good community outreach skills, but little business experience, and often lack the ability to provide relevant advice;

Welfare and business goals are often mixed so staff do not know whether to be social workers or business developers;

Projects are often too complicated- involving complex marketing schemes or collective production plans, overwhelming the people they are trying to reach.

Many projects run by social service agencies are expensive, highly subsidized, and limited in their capacity to serve clients. The few that have developed clear business goals and well-defined performance standards now operate highly successful programmes. Such programmes focus on upgrading existing economic activities and providing services geared to the needs of clients.

(3) What Works

0ver the past several years, much has been learned in the way of extending credit to the poorest microentrepreneurs. Many of these lessons have been based on concepts long employed by traditional informal finance activities, which are remarkably resilient and flexible to the needs of the client. For example, rotating savings, and credit associations (ROSCAS) have also long been in existence in Asia, Africa, and Latin America. These groups typically pool members' deposits, then extend loans to members after a given period. Funds can also be disbursed in cases of member emergencies or funeral expenses.

Some of these practices have even made their ways to other countries. Acquaintances from immigrant communities form savings groups and accumulate funds which are used to start individual small businesses for each of the members in the new country. These informal sector financial services have supported the entrepreneurial success of many new arrivals in the industrialized world.

Another pervasive feature of the informal financial sector is pawning, one of the oldest forms of providing money to people who fall outside the reach of formal banks. Pawnshops provide instant small loans for short periods of time, assuring repayment by requiring physical collateral. Village money lenders also provide small loans for short periods of time unsecured by collateral to people they know well. Their interest rates are much higher than other sources of credit, but they address the specific needs of their clients.

While every project is unique, the "laws" of effective projects which employ the successful elements of financial services as they occur in the informal sector, are remarkably similar. These sources possess a significant amount of knowledge and experience in employing lending methods which have endured over time. Main lessons derived from the informal sector, which are used in this guide, include the following:

Work directly in the community
Staff should visit villages and poor neighbourhoods almost daily, calling upon existing clients and explaining requirements to potential clients. They should hold meetings in the communities. If the project is operating in a rural area, staff should visit towns and villages, perhaps on a weekly basis;

Simplify application procedures
There is little difference in the rate of loan repayment between projects that "write a book" on each applicant and those that reduce applications to one or two pages. At the microloan level, relying on peers to choose a client is an effective tool for loan security;

Extend credit quickly
Loan applicants become discouraged if they have to wait months before receiving services. They are accustomed to moneylenders who dispense money on the spot. Well managed projects extend credit in less than a month and often within a week. They disburse subsequent loans even more quickly;

Do not require records and complex business plans
Because only a small percentage of farmers, traders and micromanufacturers keep written records of any kind, successful programmes refrain from asking for records or plans;

Do not require guarantees eliminating most potential candidates
Alternative mechanisms, such as credit groups described in this guide, where business owners are mutually responsible for repaying loans, substitute effectively for conventional guarantees. The individual's reputation in the community is more important than collateral;

Work with existing economic activities, no matter how small, or work with start-ups appropriate to the community
Launching larger enterprises is seldom successful and requires extensive inputs over months and often years;

Focus initially on the local market
Local entrepreneurs and small farmers can find "niches" often invisible to outside experts. Efforts to find new markets are often costly and difficult;

Extend small, short-term loans primarily for working capital on simplified terms
Small, short-term loans not only "test" the client's commitment to repay, but also allow the client to see whether or not a loan will, in fact, help the business grow. These loans should have frequent (weekly, bi-weekly, monthly) equal payments;

Provide larger loans based on successful repayment
Virtually all successful programmes have a well defined system of providing increased loans based on successful repayment;

Charge a higher rate of interest than the market
From the perspective of borrowers, quick credit is more important than a low interest rate. From the perspective of lenders, interest must cover transaction costs and the cost of operating the project;

Assume clients, with their network of friendships and their relationships within the community, will take a major role in promoting the project
Clients form their own groups and provide one another with advice and assistance, reducing programme costs significantly. At the same time, this intensified interaction serves to develop a commitment among clients-- to the project and to each other;

Develop large-scale, self-sufficient, profitable projectsworking in close coordinationwith local banks
The involvement of the formal financial sector is vital if efforts are to reach a significant part of the rural and urban poor;

Address the needs of poor clients
Formal sector banking hours are often not convenient to the schedules of the working poor.

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