UNITED NATIONS CAPITAL DEVELOPMENT FUND    Microfinance

Issue 10 / March 2005

Issue Table of Contents

Marketplace

Made by Microentrepreneurs

Update

on the International Year of Microcredit 2005

Upcoming Events

Conferences, events and trainings.

Links

New websites and publications.

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Past Issues

To address the many challenges donors face in supporting the development of microfinance, CGAP has developed the reference Building Inclusive Financial Systems: Donor Guidelines on Good Practice in Microfinance. These guidelines compile lessons learned over 30 years about basic conditions for successful microfinance, with an emphasis on donor support to the sector realized primarily in partnership with private partners. Drawing on these lessons and the Microfinance Donor Peer Reviews and the Key Principles, Donor Guidelines provides practical, operational guidance for donor staff in the field and at headquarters who conceptualize, design, implement, and monitor programs related to improving poor people's access to financial services. The intent is not to dictate one way to support microfinance, but rather to support a diversity of approaches and priorities within a framework of basic good practice principles. Donor Guidelines also highlights issues that remain unresolved and requires further experience before consensus on good practice can be reached.

Existing donor principles for microfinance, "Micro and Small Enterprise Finance: Guiding Principles for Selecting and Supporting Intermediaries" (known as the "Pink Book") were jointly developed in 1995 by the Donors' Working Group on Financial Sector Development and the Committee of Donor Agencies for Small Enterprise Development at the World Bank. The "Pink Book" has withstood the test of time with regard to funding retail microfinance institutions (MFIs). However, microfinance is a dynamic field that has evolved significantly since the Pink Book was published. Today, microfinance is increasingly seen as an integral-no longer marginal-part of the financial system. This realization not only offers the potential for a massive increase in outreach to the poor, it also implies a much broader, more diverse, and more complex set of operational issues and institutions.

A New Vision

Through a participatory process involving multiple stakeholders, CGAP's 29 member donors have defined a vision for the future of microfinance. The new vision is one in which poor people everywhere in the developing world enjoy permanent access to a wide range of financial services, delivered by different types of financial and non-financial institutions through a variety of convenient mechanisms. Financial services for the poor encompass savings, credit, payment and transfer services, and insurance. Providers include nongovernmental microfinance institutions, savings and credit cooperatives, commercial banks, community-based organizations with bank linkages, insurance companies, state banks, and others. Donor Guidelines attempts to codify what is already known about basic principles of good practice, consolidating a body of operational knowledge that can lead to the realization of this vision.

Inclusive Financial Systems

The new vision recognizes that large-scale sustainable microfinance can be achieved only if financial services for the poor are integrated into all three levels of a financial system: micro, meso, and macro. In general, integration allows greater access to capital on the part of institutions serving the poor, better protection of poor people's savings, and increased legitimacy and professionalization of the sector. Ultimately, integration into the financial system could open financial markets to the majority of people living in developing countries, including poorer and more geographically remote clients than are currently reached.

Success in building inclusive financial systems hinges on the contributions of a wide range of actors and their ability to work together effectively. In addition, financial systems for the poor depend on existing conditions, such as infrastructure, access to markets, production technology, and availability of information to mitigate risk. The backbone of financial systems remain retail institutions that provide services directly to clients ("micro-level").

In addition, a supporting infrastructure comprising quality auditors, rating agencies, professional networks, trade associations, credit bureaus, transfer and payments systems, information technology, technical service providers, and trainers is required to reduce transactions costs, increase outreach, build capacity, and foster transparency among retail institutions. This infrastructure, known as the "meso-level," can transcend national boundaries and include regional or global actors.

Finally, a conducive and stable macroeconomic and policy environment is necessary to underpin a pro-poor financial system. Central banks, ministries of finance, and other national government entities constitute the primary "macro-level" players.

It is important to note that all aspects of an inclusive financial system may be difficult to apply in all countries. As in every other area of development, one of the most important starting points should be the country context. For instance, in countries with dysfunctional or non-existent financial systems, the entry point for building permanent access to financial services for poor people will differ from the entry point in countries with flourishing financial systems. Unequal access to financial services is also present in countries with sound financial systems, and interventions may be required to remedy market failures and expand access. A functioning financial system should be seen as a necessary, but certainly not sufficient, condition to assure permanent access to financial services for poor people.

The Role of Donors

International development partners have played an important role in supporting the emergence and development of microfinance. However, because donor programs on the ground do not consistently reflect their commitment to good practice, they have not always achieved the desired impacts. In some cases, these programs have actually retarded the development of inclusive financial systems by distorting markets and displacing local commercial initiative with cheap or free money. Donors need to recognize that they play only a supportive role and that their partners on the ground actually deliver financial services. At the very least, Donor Guidelines seeks to enforce a sort of Hippocratic oath for donors to "do no harm."

As microfinance evolves and becomes more complex, donors face an even greater challenge: enhancing professionalism and applying good practice. They must engage with a much broader range of actors at the micro-, meso-, and macro-levels, and allow private and public sector partners to fulfill their appropriate roles. The role of donors in the future of microfinance will, moreover, change in response to new challenges, such as expanding and deepening access, that the private financial system may not automatically address. All donors cannot necessarily work on all three levels of a financial system, but each intervention-whatever the level-should promote the growth of the sector as a whole. Additionally, the role of donor interventions at different levels will depend on the stage of development of the larger financial system.

One of the fundamental challenges faced by donors is how to deploy the range of instruments at their disposal to best support the emergence of inclusive financial systems. These instruments range from grants by bilateral donors and foundations for technical assistance, loan funds, institutional capacity building, and development of industry infrastructure; to soft loans from multilateral development banks to governments for a range of activities, including strengthening the enabling environment, supporting the development of industry infrastructure, and providing financial institutions with technical assistance and loans priced at or near market rates); and commercially-priced loans (quasi-equity and equity) from public-sector banking institutions.

Donors increasingly engage with national governments to integrate financial sector reforms, including financial deepening, within such country-level mechanisms as Financial Sector Assessment Programs (FSAPs), Poverty Reduction Strategy Papers (PRSPs), sector-wide approaches (SWAps) and budget support. The donors most involved in such reforms, such as the International Monetary Fund (IMF), World Bank, and other multilateral development banks, should highlight access to financial services within this broader framework. It is up to donors, working through national stakeholders like governments, civil society, and the private sector, to maximize the coherence of microfinance-related activities within this larger picture, using the good practice guidelines outlined here. One outcome of this country-level process could perhaps be a set of rules of engagement or a code of conduct

Getting the Word Out

CGAP has launched an dissemination and feedback collection campaign around the new Donor Guidelines.. The dissemination campaign began with a February 1 inter-agency event in Washington, D.C. hosted with the Inter-American Development Bank. During the first 6 months of the 2005, CGAP staff will visit about 20 member agencies for on-site presentations and discussions, in addition to presenting the guidelines in selected countries. During these visits, and through its website, CGAP is inviting feedback on donors' experiences using the guidelines. See http://www.cgap.org/donorguidelines/index.html for details or to download or order hard copies of Building Inclusive Financial Systems: Donor Guidelines on Good Practice in Microfinance.