Microfinance organisations

Access to savings and credit allows the poor to bridge the gap between irregular income and expenditure profiles. When no financial instruments are available poor often spend their money when they get it (for fear of losing it) or use inefficient non-monetary forms of savings, such as livestock or gifts. When they want to invest or face an emergency they must turn to private money lenders who charge 200%+ interest

Microfinance institutions (MFIs) are 'social' financial services institutions designed to meet this market need. To be successful, MFIs must have low costs, so they remain profitable even when transactions are small, and good credit discipline, since loans are not easily collateralized. Microfinance institutions usually achieve this by engaging the local community. The community provides low cost (often voluntary) labour, and puts pressure on borrowers who are defaulting. However, maintaining a community based organization is difficult - expertise and support from a national institution is normally needed.

There has been a great growth in microfinance organizations in Sri Lanka - it has one of the highest concentrations of microfinance institutions in the world. Yet access to microfinance is still patchy, especially in rural areas. We visited two microfinance organizations, both SANASA Societies (see Appendix 3 for more details)

SANASA Primary Society at Samanthi Stores

Current business

The Samanthi Stores Primary Society was started in 1990, at the junction of two rural roads where there are a number of shops and workshops. It now has about 570 members, and also provides services to 600 non-members. It has total assets of Rs1.9m ($19k) - a 30% increase from the end of 2005.

The society is led by the founder, Hagale Thunkama. As in all SANASA Primary Societies, the members jointly own the institution and all members meet once a month to discuss the development of the society.

The society both takes in deposits from members and gives loans. Most of the loans in the area are for micro-enterprises: working capital for small shops, equipment for mechanics, etc. There is also a large demand for borrowing from paddy farmers. But this is more risky lending since the repayment is in a lump sum and if the rice price is low for one year it is likely that many borrowers will default (i.e. lending to paddy farmers overly concentrates the society's risk). The society would prefer to lend to home gardens (small-scale growers of vegetables, spices and medicinal herbs) since these bring a more regular return.

Plans for future business

The society would like to continue to expand organically, attracting more members and increasing the savings per member. But it realizes that is has some challenges.

Firstly, there are 10 other banks and micro-finance organizations operating locally.  Mr Thunkama says the SANASA society has better approaches for poor people - for example it does not require collateral - and is more trusted. But other banks appear more professional - the SANASA society has no IT system and the building does not look so secure, so people with more money go to the larger urban banks nearby.

As a result, the society is not able to grow its deposits per customer - which are currently Rs2,500 per person (or $25). If the society had more customers it could move to a more secure place or perhaps get an IT system. It is caught in a vicious cycle of low revenue leading to low confidence and hence less business.  But the Chairman the society can grow out of this cycle - another nearby society, Bathaata, started in 1986 and now has 1000 members and Rs60m assets ($600k).

Mr Thunkama thinks he could lend more if he had more liquidity. The society already has a liquidity loan from the SANASA Development Bank for Rs250,000 ($2,500), which it has on-lent to customers at a 3% margin. It is evaluating if it should get another loan. Mr Thunkama worries that overly rapid growth using external money could damage credit discipline, but thinks the membership can take more loans now. There are still some money lenders operating in nearby areas who charge very high interest rates and he would like to put them out of business.

There is also a clear opportunity to serve people from other areas, especially further from town. The society is close to a housing project - a development of about 70 houses built for Tsunami victims. The society is working with the NGO that built the homes to make 40 of these households members and then give loans for income generation projects.

The opportunity is even greater in rural areas, where there is more demand for financial services, given the uneven income profile of most rural families and lack of institutions. Mr Thunkama would like to work in these areas, but also knows that the model does not allow a single society to cover a large area. "People have to feel a connection to the society, an ownership, or they are not loyal [and credit quality suffers]. The society cannot be too large or they lose the connection." It would be better to start up new societies in rural areas or develop the societies that already exist.

SANASA Primary Society at Thawaluwila East

Current business

Thawaluwila East is a small village on the coast, just outside Ambalantota. Most of the people in the village are fishermen and paddy cultivators. The Tsunami had a major impact in this community. 27 houses were destroyed (15%) and an additional 60 were damaged (33%).

The society is also small, although most in the village are members. There are 179 households in the village of 1,500. The society has 145 members, plus 50 non-members who leave deposits with the society. The total assets are about Rs1m ($10k), making the average deposit with the society Rs5,100 per person ($51)

The society was inactive before the Tsunami. It had a large number of bad debts, most of which were a result paddy cultivators not repaying loans following a bad harvest.  But after the Tsunami the Primary Society revitalised. The community realized it needed to work together and Primary Society meetings re-started. People have started to make deposits and the society has new lending.

Post-Tsunami reconstruction projects, managed by the national Federation of SANASA Societies and the SANASA Development Bank have helped. The first project literally re-built the society - the old building was washed away in the Tsunami. Ms M N H Chandra Lalini, the Chairwoman of the society, opens the new office from 9:00 to 3:00 three days per week. She also receives advice on how to build the society from Field Officers. A second program gave grants to recapitalize debts which had become non-performing as a direct result of the Tsunami.

Plans for future business

Ms Lalini wants the society to continue to grow. She has introduced more lending products to raise liquidity for lending. She would also like to raise members' awareness of the benefits of an active cooperative society and to develop new community development programs - which will increase trust in the society and so make people more willing to leave deposits.

Ms Lalini says that they have learnt from their previous lending experience and will not become overly concentrated in one sector. They now lend more to micro-enterprises, like sweet producers, small retail shops and seamstresses.  The regular income makes these loans less risky. Paddy farmers still need credit, so they have to turn to local money lenders.

Ultimately, however, the society is likely to face difficulties as it is too small. Even if the society is able to capture all of the financial services needs of the village, with only 179 households it will always struggle to be financially viable or to invest in new systems. Thawaluwila East is quite close to Ambalantota and the society already loses customers to the more modern and better equipped urban banks located there. There are other SANASA societies near-by that the Thawaluwila East society could cooperate with, perhaps sharing infrastructure or facilities. Ultimately, it may be possible to merge and then provide the same level of service as a commercial bank, while retaining the advantages of local cooperative ownership.

Social investing

Liquidity lending

Most successful Microfinance institutions collect a majority of their funds from deposits, since this increases customer's commitment to repay loans. However, in some cases an MFI may need additional funding, for example if borrowing needs grow fast (and the institution is confident it can maintain credit quality), or if the MFI wishes to provide longer-term loans. In Sri Lanka, the SANASA movement has set up a bank to provide these needs - the SANASA Development Bank, which specializes in lending to SANASA Primary Societies. In other countries these types of banks may not be set up. Alternatively, in some cases the 'Apex bank' itself needs funds for on-lending: many of the funds that SDBL on-lends are from international partners and are ear-marked for particular sectors.

Risk reduction products

Small MFIs realize the risk of overly concentrating in one sector, since if there are problems in that sector it will put too many loans at risk, and could bring down the whole institution. However, this precludes them from lending to sectors where they could create major benefit - for example in Ambalantota where many of the local population are paddy farmers, few MFIs are willing to lend to this sector.

If the MFI could 'sell this risk', it would open up a large potential market. In theory there is no reason why this cannot be done. The challenge is pricing - both how to determine the cost of this risk and how to be able to minimize transaction costs. If all the SANASA societies worked together, through the SANASA Development Bank, there should be sufficient volume to allow the risk to be sold.

Funding support

Funding support to MFIs carries a risk. If customers perceive that the MFI is receiving significant sufficient external they may believe that they do not need to repay loans. Equally, if the MFI receives subsidies for loans it may start to lend with less attention to repayment. Ultimately this will undermine the MFI's most valuable asset - the credit discipline of its members.

Funders should restrict their involvement with MFIs to supporting the development of the institution. This will allow the institution to grow, to bring in more deposits and then lend more. It should make the institution more financially sound, by reducing unit costs and increasing profitability.

There are still a number of ways that external funders can support MFIs. They can become engaged in any part of the institution, through training, promoting best management practice, or motivating members. Two example projects are described below, which the SANASA movement is already implementing and which could be replicated in other MFIs.

Organizing new societies and disseminating best practice

The SANASA movement has 8000 societies across Sri Lanka. Yet the movement could grow more. Many societies created during rapid growth in the 1980s are now less active. In some areas there are few SANASA societies, despite the demand for credit. There are particularly few societies in the East and North of the country where travel is difficult. And a large number of the 8000 societies are now inactive.

The SANASA movement has developed an approach to initiate and support these societies. It defined a standard set of 'Best practices' at its education campus and field officers travel the country, working with the existing SANASA societies to help the societies implement these practices. Support includes leadership development, accounting, product development, building and security, etc. The field officers also work with communities who want to start a new SANASA Society to describe how a society works and to help in the initial meetings. These field officers are partially paid by the SANASA Development Bank, which is interested in developing Primary Societies as future customers, and partially by external funding.

Implementing IT into Primary Societies

Larger SANASA Societies resemble small banks. They can have several thousand members and process up to 1000 transactions per day. Already, more than 200 societies have purchased computers and use simple IT systems to manage their accounts.

The National SANASA Federation is developing standard software for roll-out to SANASA Societies. This system should use PCs for larger societies and simpler hardware, such as a hand-held credit-card reader, for smaller societies. Implementing IT allows fewer processing and accounting staff. It reduces operational risk from errors and incorrect auditing practices. It also increases customer confidence, reducing the number of customers who move their accounts to urban banks. The SANASA movement estimates that the project has an internal rate of return of approx 140%. It is currently implementing a pilot in two primary societies. 

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