Microfinance has experienced a rough patch since the beginning of the decade. To quote from a ‘systematic review’ by the UK Department of Development: “Despite the apparent success and popularity of microfinance, no clear evidence yet exists that microfinance programmes have positive impacts.” Some observers argue that it is time to consign microfinance to the dustbin of history. How is this possible when so many micro-finance institutions (MFIs) have been reporting high repayment rates, and all enthusiastically share the stories of clients who used micro-loans to transform their lives?
The discrepancy is because MFIs mostly look at the success of individual borrowers, whereas their critics look at the wider communities in which these borrowers function. When an extortionate loan is replaced with a micro-loan, the borrower gains, but the moneylender operating in the same community, loses. If you empower a woman to expand her business selling processed foods, her competitors lose – after all, both share the same market of low-income consumers. As long as microfinance does not increase the size of the pie, but just redistributes the money, no societal gain is generated and its transaction costs actually leave society poorer.
This is not the place to argue whether these criticisms are entirely fair. Nevertheless, they do provide a powerful pointer to MFIs: if they want to have a claim on public money because they are ‘doing good’, MFIs better operate in a way that ensures their lending increases the aggregate revenue of the communities in which they operate.
It remains to be seen how many MFIs will take this to heart. Interestingly, however, MFIs engaged in agricultural finance do not need to change as much to mend their ways; they already empower their clients to sell more of their stock at reasonable prices, and with lower risk, to buyers outside of the community.
Take the example of BASIX, a large MFI in India focusing on the rural poor, which started in 1996 and rapidly was seen as a success. It thus came as a shock to BASIX management when an impact assessment commissioned after 5 years of operation found that, on aggregate, the income gains of BASIX customers were disappointing, and as many as a quarter actually showed falling incomes.
In response, BASIX decided to change tack. It started to directly tackle the problems that its borrowers faced: unmanaged risks; low productivity; and unfavourable markets for both inputs and outputs. BASIX developed service packages in all three areas, and gave them equal weight to credit provision. Among other things, BASIX started providing insurance for weather risks, livestock mortality and health risks. A large extension team was established and, as well as providing soil testing and training on integrated pest management, microcredits for cows were packaged with veterinary services (such as livestock vaccination) and training was provided to farmers on feed and fodder use.
To improve market conditions, BASIX promoted various contract farming schemes. This often wasn’t easy due to the vested interests of traditional input dealers and traders, but ultimately resulted in far better incomes for farmers. The approach worked on bringing new traders to different areas to provide more competitive markets. Warehouse receipt finance was also developed so that farmers were no longer forced to sell directly after harvest, but were instead able to store their crops and receive credit against the collateral. For some commodities, such as cotton and dairy, comprehensive value chain finance schemes were developed that allowed farmers to move up the value chain and capture more lucrative markets. In order to benefit from these various services, farmers have to be properly organised, so BASIX also started providing business training to farmer groups.
All in all, BASIX did not just tailor its loan products to agricultural cycles (there were no daily repayments in small amounts, as in traditional microfinance), but also tried to ensure that its clients’ revenues would increase enough to repay their loans without difficulty. BASIX began to build risk mitigation into its loan structures to protect clients from external risks. These are not traditional considerations for a bank or microfinance institution, but they make sense in agri-finance. A financier may end up with more agronomists and extension agents on its payroll than credit officers, but if this ensures profitability, why not?
Other MFIs successfully engaged in agricultural lending have taken similar approaches, and some have even added micro-leasing to finance agricultural equipment, which is another way to increase the size of the pie. There is undoubtedly still room to learn and improve, in particular by fully adopting all the benefits of modern ICTs. By building microfinance into a large package that includes risk management, support for improved yields and better market linkages, MFIs have shown that reports of the impending death of microfinance, at least for agriculture, are greatly exaggerated.