By Patrick Honohan (September, 2004)
http://www1.worldbank.org/finance/assets/images/0821359673_Financial_Sector_Policy_and_the_Poor.pdf
Abstract
This paper presents empirical evidence to support the argument that a strong financial sector is also pro-poor and that the mainstream financial institutions can co-exist with microfinance organizations in meeting the objectives of tackling poverty and achieving economic growth. The performance of both kinds of institutions and their observed impact is also analyzed. Moreover, the author makes some policy suggestions to achieve full potential in providing efficient financial services to the poor.
The key points presented by the author are:
Empirical evidence supports that a strong financial sector is associated with lower levels of poverty, while such econometric studies of microfinance have failed to find a similar result.
Microfinance sector is too small to threaten a countryAos financial sector. Evidence suggests that at most it represents 7% of M2 and much lower for the majority of countries.
Mainstream financial institutions tend to converge with microfinance as competition increases and excess liquidity disappears in the mainstream sector and MFIs achieve scale and become self-sustainable. Already, both kinds of institutions have more similarities than differences.
Government policies should avoid setting interest rate ceilings, which could create perverse incentives, but should find ways to reduce predatory lending, by concentrating on credit education and legal protection.
Microfinance and financial sector institutions are needed and complement each other in tackling poverty.
Summary
The author presents several arguments to support that a pro-poor approach to access to finance should include the mainstream financial sector:
Econometric studies show substantial evidence to support that the mainstream financial sector is associated with less poverty. On the other hand, evidence on microfinance performance has failed to do so and shows that it has reached very little penetration, in most countries it is still below 1% of M2. In terms of population, the results are similar with only a few countries reaching above 3% of total population. This suggests that there is no potential threat to the stability of the financial sector, since microfinance represent a very small share of the market.
Mainstream financial sector and microfinance are thought to be very different, but there are more similarities than differences. Both sectors aim to achieve profitability and aim to do so by doing a careful choice of their borrowers. MFIs are using a set of innovative techniques to reach the same goals as mainstream institutions. Moreover, microfinance is increasingly more focused on commercialization and professionalization, both goals of the mainstream sector as well.
The author envisions a consolidation of the microfinance sector into a small number of large (deposit-taking) entities, which would be competing in the margin with commercial institutions. Additionally, the mainstream sector will increase its interest in the lower-end of the market at a large scale and will converge with microfinance. Government policies could play a role in achieving this goal if policies are set to increase competition in the financial sector, which would remove excess profitability, thus making the microfinance sector more attractive.
Changes in legal and information regulation directed to strengthen the performance of microfinance institutions have a direct positive impact on the financial sector, especially those that are aimed towards deposit-taking institutions, since a collapse of the microfinance sector could damage credibility and bring some instability to the financial sector. On the other hand, the implementation of prudential regulation to microfinance could distract the authorities and increase risk in the mainstream sector.
Both microfinance and mainstream financial institutions are needed and should be considered complementary in tackling poverty. Considering strengthening the performance of one on top of the other would be a mistake.