BY BEATRICE SABANA

CONSULTANT

PLANNING FOR FINANCIAL SELF SUFFICIENCY WHILE SERVING THE POOREST CLIENTS

COURSE OBJECTIVES

OVERVIEW OF MICROFINANCE AND POVERTY ALLIEVATION

FINANCIAL SELF-SUFFICIENCY VS REACHING THE POOREST

FSS RATIO ANALYSIS STRATEGIES FOR ATTAINING FSS CASE STUDIES

Microfinance as a tool for poverty alleviation:

‘The Millennium Development Goal of halving world poverty by 2015 sets a big challenge for MFIs. MFIs have demonstrated that microfinance can reach the very poor and facilitate improvements in the welfare of the poor and their families. However, despite the growing microfinance sector, a majority of the poor and poorest have not been reached by MFIs- only around 10% of the estimated 500 million or more poor people worldwide who have a demand for financial services are currently being reached (about 55 million). On a regional basis, the coverage remains very low. In Asia, among 157.8 million poorest families1 (ie.those living under one dollar a day PPP), only 14% are being reached. In Africa and Latin America, only 12.9% of all poorest families have access to financial services’

Microfinance as a tool for poverty alleviation

Microfinance is defined as the provision of financial services, primarily savings and credit, to poor households which do not have access to formal financial institutions.

It is generally accepted that that access and efficient provision of microcredit can enable the poor to smooth their consumption, better manage their risks better, gradually build their assets, develop their micro enterprises, enhance their income earning capacity, and enjoy an improved quality of life. Microfinance services can also contribute to the improvement of resource allocation, promotion of markets, and adoption of better technology; thus, microfinance helps to promote economic growth and development.

Inherent in this definition is the fact that microfinance must keep a focus on its poverty alleviation goal.

Financial Self-Sufficiency vs. Reaching the Poorest

There is an emerging divide in the microfinance industry concerning possible trade-offs between reaching institutional financial self-sufficiency (IFS) and working with the poorest people.

As Elisabeth Rhyne noted, everyone in the microfinance industry wants to “provide credit and savings services to thousands or millions of poor people in a sustainable way.” (Rhyne 1998, 6)

it is generally recognized that reaching financial self-sufficiency is an important goal in the quest to provide financial services to the poor. The Microcredit Summit in 1997 set a nine-year fulfillment campaign of reaching 100 million poorest families with credit by 2005 – and estimate the cost of this endeavor to be about $21.6 billion. Little more than half of this amount is expected to come from donor funds. (Declaration and Plan of Action 1997. Self-sufficient institutions will play a crucial role in reaching this goal as microfinance institutions (MFIs) scale up their operations to reach greater numbers of poor people.

Is there a trade off?

The debate on a possible trade off between financial self sufficiency and serving poor clients is often based on the fear that focus on financial self-sufficiency will divert MFIs’ attention and resources away from their core objective of poverty alleviation and away from their core poor market. This fear is based on several factors. The poor tend to be concentrated in harder-to-reach rural areas characterized by weak and fragmented markets for goods and services, dispersed populations, limited non-farm activities, and underdeveloped infrastructures. These factors imply both relatively high costs per dollar lent and relatively greater risk. Other factors implying relatively high administrative costs are the difficulties inherent in identifying and reaching poor persons and the heavy delegation and monitoring costs resulting from the lack of physical collateral. The lack of physical collateral in turn implies higher credit risk. In short, delivering financial services to the poor is comparatively costly and difficult, and is fraught with risk, none of which bodes well for long-term financial self-sufficiency. Hence the belief (or fear) that financial self-sufficiency and depth of outreach are inherently dichotomous.

The debate on FSS and poverty alleviation was ignited by a book that had case studies of 12 MFIs in Asia, Africa, and Latin America argued that MFIs working with the poorest would experience a trade-off with IFS. Specifically, it concluded that, “at a given point in time [MFIs] can either go for growth and put their resources into underpinning the success of established and rapidly growing institutions, or go for poverty impact…and put their resources into poverty-focused operations with a higher risk of failure and a lower expected return”(Hulme & Mosley, Published in CGAP Focus noe. 5 ).

Is there a trade off

However, this argument was disapproved by (Christen, 1997; Christen and others, 1995; and Gulli, 1998, p. 28). A study of 11 successful microfinance programs in three continents found that, “Among high-performing programs no clear trade-off exists between reaching the very poor and reaching large numbers of people”. They concluded that their results showed that, “…full self-sufficiency can be achieved by institutions serving the very poor….” . Thus it is not the clientele served that determines an MFI’s potential for IFS10, but the degree to which its financial services program is well-designed and managed.

Another study by Gary Woller for the SEEP Network found that that financial self-sufficiency and depth of outreach were not are not inherently dichotomous. Rather, they have a complex, multidimensional relationship that depends on several factors, both direct and indirect. He argued that financial self-sufficiency is driven by factors that may or may not facilitate deep outreach. The exact relationship between financial self-sufficiency and depth of outreach in a given situation will depend on the way in which all these factors interact with each other.

Is there a trade off

In a paper written to show how microfinance programs can be financially self-sufficientwhile positively impacting the lives of the poorest, Anton Simanowitz showed that participants in both CRECER in Bolivia and SHARE in India had significant changes in terms of income sources as well as consumption smoothing. 76% of SHARE’s clients (which total more than 100,000 people) had significantly reduced their poverty and one-third of them are no longer poor.At CRECER, 66% of clients had increased income and 41% of clients had increased asset ownership, particularly in the purchase of animals. (Simanowitz 2002, 22-25)

FSS Data

Evidence from the microfinance field shows that that there are MFIs which have attained financial self sufficiency while serving the poorest of the poor.

Marketing Mix Bulletin 2009 showed that many MFIs have not achieved FSS

African MFIs had FSS of 96% compared to Asian MFIs with 108%.

More MFIs have attained OSS than FSS

FINANCIAL SELF SUFFICIENCY

FSS is defined as the ability of an MFI to cover all actual operating expenses, as well as adjustments for inflation and subsidies, with adjusted income generated through its financial operations.

Inflation adjustments are twofold: (i) to account for the negative impact, or “cost” of inflation, on the value of your equity* and (ii) to account for the positive impact of the re-valuation of non-financial assets* and liabilities* for the effects of inflation. Similarly, there are two types of subsidies which must be adjusted for: (i) explicit subsidies to properly account for direct donations* received by your MFI to cover operating expenses and (ii) implicit subsidies to account for loans received by your MFI at a below market rates and in-kind donations such as rent-free facilities, staff paid by third-parties, technical assistance, and the use of a third party infrastructure (e.g., communication facilities, etc.).

Such adjustments are necessary as MFIs often operate in highly inflationary environments and/or receive significant “support” from third parties – such as government or donors – in the form of implicit subsidies. The adjustments take this “support” into account and allow an MFI to understand the potential commercial viability of its financial services operations. This is done by comparing adjusted operating income to adjusted operating expenses. If the figure is greater than 1.0, then an MFI has reached IFS. If IFS has not been achieved, the withdrawal of such “support” could ultimately result in the failure of an MFI, with potentially disastrous effects for the poor clients being served

Financial Self sufficiency

FORMULA

Adjusted Financial Revenue/Adjusted

(Financial Expense + Impairment Losses on Loans + Operating Expense)

Why is FSS Important for MFIs

‘As MFIs begin to wean themselves away from their dependence on subsidies and start to adopt the practices of good banking they will be forced to further innovate and lower costs. Not only may this ultimately mean better service for poor borrowers, but more importantly, it is argued that as MF[I]s become profitable they will be able to increasing[ly tap into the vast ocean of private capital funding. If this happens the microfinance sector as a whole will soon be greatly leveraging the limited pool of donor funds and massively increasing the scale of outreach in ways that it is hoped could begin to make a truly significant dent on world poverty.5 (Conning, 1998’)

Is there a trade off?

The debate on a possible trade off between financial self sufficiency and serving poor clients is often based on the fear that focus on financial self-sufficiency will divert MFIs’ attention and resources away from their core objective of poverty alleviation and away from their core poor market. This fear is based on several factors. The poor tend to be concentrated in harder-to-reach rural areas characterized by weak and fragmented markets for goods and services, dispersed populations, limited non-farm activities, and underdeveloped infrastructures.These factors imply both relatively high costs per dollar lent and relatively greater risk. Other factors implying relatively high administrative costs are the difficulties inherent in identifying and reaching poor persons and the heavy delegation and monitoring costs resulting from the lack of physical collateral. The lack of physical collateral in turn implies higher credit risk. In short, delivering financial services to the poor is comparatively costly and difficult, and is fraught with risk, none of which bodes well for long-term financial self-sufficiency. Hence the belief (or fear) that financial self-sufficiency and depth of outreach are inherently dichotomous.

The debate on FSS and poverty alleviation was ignited by a book that had case studies of 12 MFIs in Asia, Africa, and Latin America argued that MFIs working with the poorest would experience a trade-off with IFS. Specifically, it concluded that, “at a given point in time [MFIs] can either go for growth and put their resources into underpinning the success of established and rapidly growing institutions, or go for poverty impact…and put their resources into poverty-focused operations with a higher risk of failure and a lower expected return”(Hulme & Mosley, Published in CGAP Focus noe. 5 ).

Is there a trade off

However, this argument was disapproved by (Christen, 1997; Christen and others, 1995; and Gulli, 1998, p. 28). A study of 11 successful microfinance programs in three continents found that, “Among high-performing programs no clear trade-off exists between reaching the very poor and reaching large numbers of people”. They concluded that their results showed that, “…full self-sufficiency can be achieved by institutions serving the very poor….” . Thus it is not the clientele served that determines an MFI’s potential for IFS10, but the degree to which its financial services program is well-designed and managed.

Another study by Gary Woller for the SEEP Network found that that financial self-sufficiency and depth of outreach were not are not inherently dichotomous. Rather, they have a complex, multidimensional relationship that depends on several factors, both direct and indirect. He argued that financial self-sufficiency is driven by factors that may or may not facilitate deep outreach. The exact relationship between financial self-sufficiency and depth of outreach in a given situation will depend on the way in which all these factors interact with each other.

In a paper written to show how microfinance programs can be financially self-sufficientwhile positively impacting the lives of the poorest, Anton Simanowitz showed that participants in both CRECER in Bolivia and SHARE in India had significant changes in terms of income sources as well as consumption smoothing. 76% of SHARE’s clients (which total more than 100,000 people) had significantly reduced their poverty and one-third of them are no longer poor.At CRECER, 66% of clients had increased income and 41% of clients had increased asset ownership, particularly in the purchase of animals. (Simanowitz 2002, 22-25)

FSS Data

Evidence from the microfinance field shows that that there are MFIs which have attained financial self sufficiency while serving the poorest of the poor.

Marketing Mix Bulletin 2009 showed that many MFIs have not achieved FSS

African MFIs had FSS of 96% compared to Asian MFIs with 108%.

More MFIs have attained OSS

FINANCIAL SELF SUFFICIENCY

FSS is defined as the ability of an MFI to cover all actual operating expenses, as well as adjustments for inflation and subsidies, with adjusted income generated through its financial operations.

Inflation adjustments are twofold: (i) to account for the negative impact, or “cost” of inflation, on the value of your equity* and (ii) to account for the positive impact of the re-valuation of non-financial assets* and liabilities* for the effects of inflation. Similarly, there are two types of subsidies which must be adjusted for: (i) explicit subsidies to properly account for direct donations* received by your MFI to cover operating expenses and (ii) implicit subsidies to account for loans received by your MFI at a below market rates and in-kind donations such as rent-free facilities, staff paid by third-parties, technical assistance, and the use of a third party infrastructure (e.g., communication

facilities, etc.).6 In analyzing your MFI’s performance, such adjustments are necessary as MFIs often operate in highly inflationary environments and/or receive significant “support” from third parties – such as government or donors – in the form of implicit subsidies. The adjustments take this “support” into account and allow an MFI to understand the potential commercial viability of its financial services operations. This is done by comparing adjusted operating income to adjusted operating expenses. If the figure is greater than 1.0, we say an MFI has reached IFS. If IFS has not been achieved, the withdrawal of such “support” could ultimately result in the failure of

an MFI, with potentially disastrous effects for the poor clients being served

Financial Self sufficiency

FORMULA

Adjusted Financial Revenue/Adjusted

(Financial Expense + Impairment Losses on Loans + Operating Expense)

Sustainability Is: FA1-O3

from Financial Revenuefrom Financial Revenue

coverage ofcoverage of: Financial Expenses (incl. cost of funds + inflation) +Loan

Loss+Operating Expenses (incl. personnel and administrative

expenses)

+

Capitalization for Growth

Sustainability Equation

FA10-O1b

$ Capitalization

forGrowth

Adjustments:SubsidiesInflation

PARImpairmentLosses on

LoansOperating

CostsCost of Funds

SufficiencyLevels

OperatingIncome > Costs

An MFI is PROFITABLE when

FA10-O2

FINANCIAL REVENUE

ADJUSTED FINANCIAL AND

OPERATING EXPENSE

is

greater

than

Sustainability and Profitability Ratios and Formulas (continued)

FA10-O6b

RATIO FORMULA

Return on Equity (ROE)

Net Operating Income − TaxesAverage Equity

Adjusted Return on

Equity (AROE)

Adjusted Net Operating Income − TaxesAverage Adjusted Equity

GROWSustainability and Profitability Ratios

FA10-O7a

Ref. DESCRIPTION 2002 2003 2004

R1 Operational Self-Sufficiency Ratio

a Financial Revenue 4,719 6,342 10,082b Financial Expense 371 292 823c Impairment Losses on Loans 145 262 430d Operating Expense 2,760 3,264 4,562e b + c + d 3,276 3,818 5,815

R1 Operational Self-Sufficiency Ratio = a/e 144.05%

166.11%

173.38%

Adj R1

Financial Self-Sufficiency Ratio

a Financial Revenue 4,719 6,342 10,082b Adjusted Financial Expense 4,286 5,876 9,349c Adjusted Impairment Losses on Loans 186 262 507d Adjusted Operating Expense 2,808 3,312 4,610e b + c + d 7,280 9,450 14,466

Adj R1

Financial Self-Sufficiency Ratio = a/e 64.82%

67.11%

69.69%

GROW Sustainability and Profitability Ratios (continued)

FA10-O7b

Ref. DESCRIPTION 2002 2003 2004

R2 Return on Assets (ROA) Ratio

a Net Operating Income 1,443 2,524 4,267b Taxes – 20 31c a − b 1,443 2,504 4,236d Average Assets 17,283 23,824 37,718

R2 Return on Assets (ROA) Ratio = a/d 8.35%

10.51%

11.23%

Adj R2

Adjusted ROA (AROA) Ratio

a Adjusted Net Operating Income (2,561) (3,108) (4,384)b Taxes – 20 31c a − b (2,561) (3,128) (4,415)d Adjusted Average Assets 17,301 23,974 38,032

Adj R2

Adjusted ROA (AROA) Ratio = a/d −14.80

%

−13.05

%

−11.61

%

GROW Sustainability and Profitability Ratios (continued)

FA10-O7c

Ref. DESCRIPTION 2002 2003 2004

R2 Return on Equity (ROE) Ratio

a Net Operating Income 1,443 2,524 4,267b Taxes – 20 31c a − b 1,443 2,504 4,236d Average Equity 6,937 9,653 14,378

R2 Return on Equity (ROE) Ratio = a/d 20.80%

25.94%

29.46%

Adj R2

Adjusted ROE (AROE) Ratio

a Adjusted Net Operating Income (2,561) (3,108) (4,384)b Taxes – 20 31c a − b (2,561) (3,128) (4,415)d Adjusted Average Equity 6,955 9,803 14,691

Adj R2

Adjusted ROE (AROE) Ratio = a/d −36.83

%

−31.91

%

−30.05

%

STRATEGIES FOR ENHANCING FSS

CASE STUDIES