Small & Microenterprise Finance:|
Principles for Selecting & Supporting Intermediaries
This document is a joint product of the Donor's Working Group on Financial Sector Development and the Committee of Donor Agencies for Small Enterprise Development. It was apparently inspired by and is largely consistent with the recommended standards for support set out by a UN expert group of leading small and microenterprise practitioners convened by Women's World Banking in January 1994.
The purpose of these principles is to establish common standards for
donor agencies to apply in supporting broader access to financial services
for micro and small enterprises. Such enterprises have historically lacked
access to the formal financial system, but the growing success of many
institutions provides confidence that access can be provided sustainably in
many settings. It has now become possible to identify and agree upon the
basic principles that support successful micro-level finance, so that donors
can work in concert to ensure that lessons of success are translated to the
institutions they support.
The framework for donor support to micro and small enterprise finance
centers on two equally important and complementary objectives. First,
outreach embodies the aim of expanding access to increasing numbers of
low-income clients. Second, sustainability provides the means to expand and
maintain outreach. These concepts underpin the guiding principles described
Different types of micro and small enterprise clients have different
characteristics and demand different services. Hence it is desirable to
encourage a range of institutions that use specialized methods to serve
their particular market niches. These can include commercial and development
banks, credit unions, mutual or community banks, non-governmental
organizations (NGOs), finance companies, cooperatives, savings and credit
associations, and other specialized intermediaries. At
the same time, however, this document is based on the premise that
fundamental principles of finance apply widely and must be observed by all
institutions if they are to succeed. Moreover, donors must design their
support mechanisms in ways that are consistent with best international
practices and long-run development of a sound financial system.
This statement of guiding principles first identifies characteristics
donors should seek in selecting institutions to support. It then describes
appropriate forms of donor support. An annex lists reporting standards on
outreach and financial performance.
I. Institutional Performance Standards and Plans
Intermediaries seeking support should be able to demonstrate the
following characteristics, either in current operations or through credible
plans underpinned by concrete measures. Since institutions are at different
stages of development, it may be appropriate in some cases to adopt modified
standards for limited support to new or transforming institutions.
A. Institutional Strengths
- Institutional culture, structures, capacities, and operating systems that
can support sustained service delivery to a significant and growing number
of low income clients. Requirements include a sound governing structure,
freedom from political interference, good fit to local context, competent
and stable staff, a strong business plan for expansion and sustainability,
and mission and vision which create a sense of purpose, ownership, and
- Accurate management information systems that are actively used to make
decisions, motivate performance and provide accountability for funds. Such
systems are essential for effective and efficient management.
- Operations that manage small transactions efficiently, with high
productivity, as measured by variables such as loans per staff and operating
costs as a percentage of average annual portfolio (while maintaining
- Meaningful reporting standards. Transparent financial reporting that
conforms to international standards and allows prospective funders to
evaluate performance adequately. At a minimum, the raw data listed in the
Annex should be reported, and institutions should regularly monitor
financial condition using appropriate financial ratios derived from such
B. Quality of Services and Outreach
- Focus on the poor. Evidence of service to low-income clients, women and
men, especially clients lacking access to other financial institutions. The
focus need not be exclusive, as mainstream institutions such as banks are
encouraged to become providers, but it must entail a distinct commitment to
reaching the poor.
- Client-appropriate lending. For example, for micro-level clients,
institutions should feature quick, simple and convenient access to small,
short-term loans, often short-term, that are renewed or increased based on
excellent repayments. Use of collateral substitutes (e.g., peer guarantees
or repayment incentives) or alternative forms of collateral to motivate
repayment. Emphasis on character-based lending for smaller loans, with
simple cashflow and project appraisal for larger and longer term loans.
- Savings services. Offering savings mobilization services, where legally
possible and economically feasible, that facilitate small deposits,
convenient collections, safety, and ready access to funds -- either
independently or with another institution.
- Growth of Outreach. Making significant progress in expanding client reach
and market penetration, demonstrating both strong client response to services
offered and competence in service delivery management.
C. Financial Performance
- Appropriate pricing policies. Offering loans at rates sufficient
eventually to cover the full costs of efficient lending on a sustainable
basis (after a reasonable start-up period), recognizing that poor
entrepreneurs are able and willing to pay what it costs an efficient lender
to provide sustainable financial services. Interest charges by the retail
unit should be set to cover the costs of capital (at the opportunity cost,
including inflation), administration, loan losses and a minimum return on
- Portfolio quality. Maintaining a portfolio with arrears low enough that
late payments and defaults do not threaten the ongoing viability of the
institution. For example, organizations with loans in arrears over 30 days
below 10 percent of loans outstanding and annual loan losses under 4 percent
of loans outstanding satisfy this condition.
- Self-sufficiency. Steadily reducing dependence on subsidies in order to
move toward financial self-sufficiency. Achieving operational efficiency,
i.e., covering all administrative costs and loan losses with client revenues
within a reasonable time period, given local conditions. International
experience shows that successful intermediaries have achieved operational
efficiency in three to seven years, and full self-sufficiency, i.e., covering
all financing costs at non-subsidized rates within five to ten years.
- Movement toward financial independence. Building a solid and growing
funding base with clear business plans, backed by operational capacities,
that lead to mobilization of commercial funds from depositors and the
financial system, and eventually to full independence from donor support.
Financial performance standards apply only to activities that are an integral
part of providing financial services. If programs also provide non-financial
services, such as business advisory
services, health, or education they must account for such services separately
services. Standards for financial self-sufficiency do not apply to such
services, and defining appropriate standards for non-financial services is
beyond the scope of this document.
II. Strategies for Donor Support
Funding based on large, ongoing subsidies with a charity rationale has
failed. Such programs have drained resources without becoming sustainable,
and have contributed to the mistaken notion that the poor are unbankable.
Funders should provide financial and other support in forms that foster
the movement to scale, financial self-sufficiency, and independence from
donor support, taking into account the particular characteristics of
different types of institutions.
- Appropriate uses for grants.
- 1.1 Institutional development. Support for institutional development is
appropriate at all stages of an institution's life, and for a wide range of
institutions, although the nature and extent of such support should evolve
with the institution. Such support should become more selective, as
institutions become able to meet more of their organizational development
needs from within. It should also become more specialized, as institutions
tackle more difficult problems.
- 1.2 Capitalization, or grants for equity are of strategic importance in
enabling organizations to build a capital base. Capitalization can be used
to generate investment income, build the loan portfolio, and leverage funds
from local banks. One of the key purposes of providing capital funding is to
enable institutions to mix costs of grant funds with commercial sources
during the period it takes to build efficient operations and scale.
Externally-financed capitalization should be used as a catalyst and
complement to domestic mobilization of funds by local institutions. Grant
equity contributions can also help institutions seeking to become formal
financial intermediaries to meet minimum capital requirements.
- 1.3 Operating losses. Donors should avoid covering operating losses
except during a clear, time-limited start-up or expansion phase. By the
nature of the small loan business every program will take some time to reach
a break even point. Donors should be willing to provide support during that
time. Afterwards, however, such support becomes counterproductive.
- 1.4 Fixed assets. Donors may wish to support purchase of fixed assets,
such as computers, vehicles or premises. Such funding may be seen as
contributions to the equity base of the institution.
- Appropriate uses of loans. Donor support through loans is appropriate for
lending-based institutions that meet performance standards. However, loan
capital from local and commercial sources should be sought as early as
possible, even at start-up. Care should be taken to avoid burdening young
institutions with foreign exchange risk in loans denominated in foreign
currency, unless adequate precautions are taken. Donors are also advised to
be careful not to undermine savings mobilization efforts of savings-based
institutions, such as savings and credit associations by making loans
available to them below the cost of mobilizing funds locally.
- Commercial sourcing of funds. The transition to fully commercial sources
of funding requires special forms of support that help introduce institutions
to the financial system. Donors can act as catalysts to effect this
transition through means such as:
- 3.1 Investor equity, from both official and private sources. Donor
support can help leverage private investment.
- 3.2 Second-tier operations, which raise funds from commercial sources
and onlend to microenterprise finance institutions.
- 3.3 Partial guarantees of loans made by commercial banks to NGOs.
- Coherence of donor policies. Institutions following sound principles for
sustainability must not be undermined by others providing competing services
below cost or in ways that cannot be sustained. When providing subsidies
(grant or loan) to small and microenterprise institutions, donors should
ensure that they coordinate that support with other funders, such that
institutions are given clear incentives to become financially viable. In
particular, donors need to consult each other regarding appropriate interest
rates and other terms on which assistance to any given institution
is supplied. Donors should also coordinate institutional support with
sectoral policies such that financial institutions, including informal and
semi-formal sectors, find enabling conditions for institutional development
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