A. Purpose and Background of This Special Issue
This section provides a summary of the findings of the individual articles in this special issue. We conducted a two-year research project titled “Role of Small-Scale Finance in Rural Development: Rural Finance and Microfinance” from 2007 to 2009, which aimed at improving our understanding of the roles and functions of microfinance and small-scale finance in India and Indonesia. This special issue is a collection of studies selected from our research.
The sphere of interests of microfinance has been expanding. In addition to savings and insurance, a much wider range of microfinance services are now under consideration, such as the necessity of long-term savings or pensions for old-aged poor people (Ratherford 2008). Depending on the integration of formal financial markets, the means of fundraising also vary: for example, IPOs, bond issuing, and investment by private equity funds. Studies cannot keep up with such dynamic movement in the practice of microfinance. Capturing the whole movement of recent developments in microfinance is beyond the scope in this issue, but our studies try to explain the new directions of microfinance. The focus of each article varies, but each one examines recent developments in microfinance and explores recent topics in order to fill the gap between academic studies and practice.
B. Focus and Findings of the Articles
Kono and Takahashi (2010) examine the existing literature to show how the microfinance revolution is truly revolutionary. Their focus is on: (1) how to conduct valid and reliable impact evaluations of microcredit, (2) what the recent empirical literature tells us about the impact of microcredit, (3) what the economic theory and empirical literature tell us about the important factors for the high repayment rates in microcredit programs, and (4) what challenges microfinance faces. They argue that the microfinance revolution is revolutionary and has achieved high repayment rates that could not be attained in the past subsidized credit programs. They also label the introduction of insurance products by microfinance as an innovation because virtually no institutions have ever tried such an introduction in developing countries. However, judging from empirical evidence, there still remains room for improving performance, especially in terms of impact on and outreach to the poor. Based on their evidence, Kono and Takahashi contend that microfinance is developing in a promising direction but has yet to reach its full promise.
In the sphere of microinsurance, there are three crucial problems: low take-up rates, high claim rates, and low renewal rates. Ito and Kono (2010) investigate the take-up problem using household data collected in Karnataka, India. This is the first attempt to examine the problem of microinsurance take-up based on two major theories of behavioral economics: the prospect theory and hyperbolic discounting. The prospect theory presumes that people behave in a risk-averse way in evaluating gains but in a risk-loving way in evaluating losses. Because insurance covers losses, Ito and Kono suspect that prospect theory can explain the low take-up rates, and they find some support for this. Those who are risk loving in evaluating losses are less likely to purchase insurance, although it is statistically significant only in some specifications. They also find that households whose heads have a hyperbolic discounting factor are more likely to purchase insurance, consistent with their theoretical prediction of demand for commitment. The authors find some evidence for the existence of adverse selection: households with a higher ratio of sick members are more likely to purchase insurance.
Three articles explore three current topics and focus on the experience in Indonesia. The three topics are: the effect of introducing new products on client credit choice, the impact of microcredit, and the financial sustainability of MFIs in Indonesia. Tsukada, Higashikata, and Takahashi (2010) and Takahashi, Higashikata, and Tsukada (2010) use panel data (for 450 households) collected in Gresik, East Java, Indonesia. They conducted surveys in 2007 and 2008 on clients and non-clients of a people's credit bank (bank perkreditan rakyat, BPR) located in East Java. The BPR under study was developed by the largest nongovernmental organization in the country, Yayasan Bina Swadawa. The panel data are useful for displaying the dynamic changes in household behavior associated with a wide variety of microfinance services in Indonesia.
Indonesia has a long history of commercial microfinance going back to the village credit boards (badan kredit desa) started in 1896. In addition, there are large numbers of microfinance programs and MFIs in the country. Microfinance programs are supported by the government and international institutions targeting the poorest of the poor, the economically active poor, and micro and small enterprises, with assistance in the form of cash transfers, scholarships, and technical business support.
Indonesia's microfinance system includes several types of institutions: commercial banks with microfinance operations, such as Bank Rakyat Indonesia (BRI), which is a world famous MFI; secondary banks known as BPR, which is a commercialized but small-scale unit bank; and cooperatives, savings, and credit associations, and self-help groups. In addition to the formal MFIs and microfinance programs, the activities of the rotating savings and credit association or arisan have long been very common and accepted as a part of daily financial activities. Many studies on microfinance have been conducted in Indonesia. In particular, the very wide network of BRI has motivated many studies, including Robinson (2002) and Yaron (1992). BRI provides a contrastive microfinance model to Grameen Bank. Features of BRI can be found in its subordinate organization, the local unit called unit desa (BRI-UD). BRI-UD has a nationwide network of 4,046 units. The success of BRI is attributable to its financial self-sufficiency, high profitability, and high repayment rates of more than 99%. BRI lends to all industries, not only to the agriculture sector, and introduced small account deposit products in the 1980s named SIMIPEDES and SIMSKOT, which are deposits without a withdrawal limit. The wide coverage of sectors and range of financial product choices has contributed to the successful expansion of BRI-UD.
Although the success of BRI has been important, our focus is on BPRs. These are commercial banks that have been expected to play a central role in small-scale lending to the productive poor and to micro, small, and medium enterprises in Indonesia. The total number of BPRs is 1,765, with each BPR being very small and a unit bank. BPRs continue to provide smaller-scale credit than BRI. Our investigation of BPRs reveals problems inherent in the commercialization and competitiveness of the microfinance market. We also succeed in setting a unique research environment, where a BPR provides small-scale, noncollateral loans to the poor. We took advantage of this opportunity to measure the actual impact of microcredit on people's welfare and choice behavior. Our targeted people were not poor enough to receive the benefits of the government microfinance program, which targets the poorest of the poor, and not rich enough to obtain credit from commercial banks easily.
Tsukada, Higashikata, and Takahashi (2010) examine the empirical determinants of how heterogeneous households demand different types of loan products in a credit market in Indonesia. A unique situation arose that allowed them to make a first-time effort to apply the mixed logit model to analyze the effect of a new loan product. This situation was a microfinance institution's launching of its micro-lending business in the survey area during this study's survey period. The results show that small-scale loans from the formal sector without collateral requirements greatly increase overall credit access. Households in self-employed businesses prefer formal credit as a stable financing source but are impeded in receiving formal credit when they are located in rural areas, probably due to high transaction costs. The poorest households cannot exploit new credit opportunities as much as middle-income households, even if the credit scale is very small. The article reveals the heterogeneity of households in their preferences for different credit attributes, which suggests the development of a diversity of loan products for further improving credit accessibility in Indonesia.
Takahashi, Higashikata, and Tsukada (2010) is one of the few studies to systematically evaluate the outreach and impact of microcredit on the welfare of clients, especially the poor, in the context of Indonesia. In doing so, they apply a rigorous impact evaluation technique, i.e., propensity score matching using the difference-in-difference method. The distinct features of the credit scheme under study are that it is collateral-free on a small scale, which is in sharp contrast to most microcredit institutions in the country that tend to lend a relatively large amount of money and demand collateral in loan applications. The authors' results show that although collateral ownership is indeed not an important determinant of participation in the microcredit scheme under study, relatively better-off families gain access to microcredit. Moreover, the impact of microcredit on various household outcomes is generally statistically insignificant, except for sales of nonfarm enterprises for the wealthy and schooling expenditures for the poor, implying that the credit scheme under study might not have an impact on poverty alleviation in Indonesia, at least in the short term.
Shifting the discussion from the small credit taker to the small credit supplier, Hamada (2010) in this issue addresses the problem of the financial self-sufficiency and sustainability of commercialized microfinance institutions. It has been argued that an advantage of commercialization is its use of market-based funds; however, securing finance sources is a crucial problem for commercialized microfinance institutions. She focuses on the problem as it affects BPR and examines the effects of a funding support program known as the “linkage program.”
The results of the regression analysis, using financial data from 1,104 BPR, reveal that bank loans from other banks have contributed to the expansion of BPR credit. Moreover, an effect of bank loans through the linkage program has been larger than that of bank loans only. Funds from saving and deposits have had the largest effect on the expansion of BPR credit. Concerning profitability, bank loans affect the returns on assets (ROA) positively, but there is no obvious effect of participation in the linkage program.
C. Future Agendas
As explored in this issue, one of the current primary interests of studies on microfinance is its impact on the poor, as it is difficult to modify the designs of microfinance business models without knowing how they affect client welfare and profits. We are still in the process of learning, and one must carefully learn from each and every study that is internally consistent to produce the externally applicable knowledge. It is important to determine the mechanisms making microfinance “successful” in the eyes of the layman, and how such mechanisms change with the exogenous conditions prevailing in different parts of the world.
However, microfinance has continued to expand its scope of interests and operations on the ground before researchers have been able to get a clear and good understand of its nature. But the many directions in which microfinance has expanded indicate to researchers the topics for future studies. We will briefly discuss some of these topics below.
The expected trend is for financial services to the poor to become more comprehensive. This trend might help to reduce the risks that the poor face and should protect them more effectively than when each service is provided separately. Accordingly, the role of commercial MFIs will become increasingly important. This reliance on commercial MFIs is necessary for expanding the scope of services. However, caution is warranted because commercial MFIs face different problems from nonprofit MFIs. For-profit MFIs face the question of whether they can develop innovations that reach poorer households than they currently do without compromising their profits. In contrast, nonprofit MFIs face the question of whether their social and economic impacts are large enough to justify and ensure receiving continuing support (Cull, Demirgüç-Kunt, and Morduch 2009). In addition to wider scope, quality of service is essential. A client-centered approach requires financial products with conditions flexible enough to suit the demands of the poor, because their incomes are small and can be insecure. This will put an additional burden on much needed cost reduction, which is already an issue for MFIs as it requires them to prepare flexible payment schedules, to accept broader purposes for loan use, and to allow longer repayment periods.
Progress in technology may be the key to reducing transaction costs in microfinance. We have already witnessed the rapid expansion of the market for mobile phones in poor countries. The expansion of mobile phone networks affords various opportunities to the poor, and it has benefited the microfinance industry in particular. Grameen Bank Village Phone and Kenya's M-PESA are good examples.
Microfinance will continue to change, but its original purpose is to provide comprehensive financial services to the poor and low-income people in a sustainable way. To achieve this objective, continued evaluation of microfinance from the standpoint of sustainability, outreach, and impact will be essential to its further development.