Why lending through community-based organisations makes sense

© fabio lamanna – 123RF.com

Today the path of credit-flow to the world of the poor is practised in five different continents with some heavily contested evidence of success. This is particularly true in the area of how effective microfinance is in alleviating poverty.

Several models of microfinance have sprung up. They include micro-credit, micro-savings, micro-insurance, and money transfer services. So what are group lending schemes, and why is there tension between them and community-based financial organisations?

Group lending

The group-lending model of micro-credit has been efficacious. Its approach draws a lot from community-based financial organisations.

Community-based financial organisations vary in size and role. They are normally a rotating savings and credit association or a burial society. They are typically made of friends, relatives, community members or workmates who group to mobilise funds for a common purpose.

Their main advantage is that they are formed by individuals who know each other. This arguably circumvents default issues.

Learning from this, the microfinance movement has copied and used the idea of groups with members who know each other to deliver lending to the poor. Yet they typically charge higher interest rates compared to mostly interest-free loans from community-based financial organisations.

In India, for example, micro-credit businesses are by and large for profit organisations. They have been heavily criticised for charging exorbitant interest rates without regard to the poors' ability to repay.

But taking the not-for-profit route is itself fraught with difficulty. Microfinance institutions in this category are under pressure to reduce their dependence on donors and to work on operational and financial self sufficiency. This is the case, for instance, with the Small Enterprise Foundation in South Africa. Its approach is to charge interest rates that cover operational expenses only.

The question is: are community-based financial organisations being undermined by microfinance organisations that replicate their group lending models while at the same time trying to achieve self sufficiency?

The pros

The fact that there are so few banks in rural, and some urban, areas of developing countries has led many to conclude that the poor are unable to save, borrow or repay without default. This is not true.

The poor save and access credit in a myriad of ways. These include rotating savings and credit associations, burial societies, stokvels, relatives, friends and workmates. They also get credit from moneylenders, but this comes at a huge cost as they are expected to pay exorbitant interest rates.

Micro finance certainly offers a more advantageous access to credit than moneylenders because they offer lower interest rates.

There are other potential advantages. Conventional microfinance organisations can form alliances, enabling community-based financial organisations a safe place to store their money. For example, Gemiridiya in Sri Lanka is a community-based financial organisation that saves with a microfinance institution.

This is advantageous for both institutions. It becomes an inexpensive source of funds for microfinance institutions. It also generates interest for community-based financial organisations and brings more security to their savings.

Partnerships can also help community-based financial organisations:

• overcome their financial constraints given that contributions from members are limited;
  
• bring in resources that can be channelled as loans where community-based organisation members become delegated monitors to promote repayment; and
  
• foster the adoption of new practices.

The cons

Micro finance and community-based financial organisations engage in the same activities. They can therefore be seen as rivals, especially for donor funding.

Microfinance organisations mainly issue productive loans. Borrowers are expected to buy assets to start small businesses. Some community savings organisations or stokvels do something similar by saving throughout the year to buy productive assets or to raise capital for businesses.

Also, micro finance, just like community-based financial organisations, face limited resources. Microfinance organisations may charge high interest rates to cover their administrative costs. This means that borrowers need to make huge profits to cover the loan costs as well as their operating expenses.

Loans from community-based financial organisations are usually interest free. Viewed this way, it makes sense for the poor to borrow free of interest from their organisations to start a small business. And it also makes sense for donor support to be directed to them.

Yet hundreds of millions of dollars from donors subsidise the micro finance movement. No subsidies are directed to most community-based financial organisations. Why?

One reason could be that community-based organisations were once thought of as fragile and economically damaging. Consequently microfinance organisations appeared more competitive and sustainable than community-based financial organisations.

There is a strong case to be made about the survival of community-based financial organisations. While not perfect, the sense of ownership is high. This, I think, is their main advantage over the microfinance movement.