July 12, 2011
Where is the micro-line-of-credit?By Timothy Ogden
I think the most important message from the raft of research on various forms of microfinance over the last two or three years is that we need to be fundamentally rethinking the products on offer. Many people have begun advocating for savings as the core product of microfinance and that’s certainly one form of rethinking. But just as important is to look at existing credit products to see if they can be tweaked to better meet the needs of clients.
Here are some highlights that indicate the need to rethink credit products:
• Field and Pande found that giving clients more time before a first payment on a loan is due changes how borrowers use funds (toward business investment)
• Karlan and Valdivia and Drexler, Fischer, and Schoar found that some very basic business and/or accounting training can increase revenues of microenterprise customers of microcredit
• Fafchamps, McKenzie, Quinn and Woodruff found significant differences in the impact of cash vs. in-kind grants and significant differences in the returns of borrowers dependent on how profitable they were before receiving the grant
• Portfolios of the Poor documents how often microcredit and other products are used for consumption smoothing
The overall impression I get is that the financial products most useful to the poor appear to be very different from the products currently being offered.
This led me to wonder why a micro-line-of-credit product has not emerged. Let me explain what I mean: Borrowers, once qualified by successfully passing through several cycles, would be granted the option of borrowing a variable amount up to a maximum threshold at any time. Repayments would be handled in much the same way as the traditional product—although at several different levels (presumably not continuously variable for simplicity’s sake) keyed to repayment of the outstanding balance within a 3 month window. The client would still be required to attend weekly meetings but at these meetings could either make a payment or draw on their line of credit (or both).
The closest offering that I know of in the microfinance world is Grameen’s “Top Up” option but that still carries a lot of seemingly unnecessary restrictions that prevents it from operating more like a line-of-credit.
A true line-of-credit would meet the obvious needs that many borrowers have for flexibility and cashflow management. The best evidence of the usefulness of the product is that the line-of-credit is the overwhelmingly product in use for small business financing in developed countries. The cashflow needs of such small businesses seem to fairly closely match those of microenterprises and poor households.
So why hasn’t such a product emerged? Would it so clearly be unprofitable or unmanageable? Is it the fault of IT systems and tracking systems that can’t keep up? Would it disrupt the financing model of microcredit by undermining the marketing narrative of microentrepreneurship? Or is it just a poverty of imagination?
Timothy Ogden is an executive partner at Sona Partners, the editor in chief of Philanthropy Action, and co-author of Toyota Under Fire. He also blogs at HBR and SSIR.