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Financial inclusion through microfinance has been a pinnacle of policy attention in most of the poor countries. Started as an initiative to promote small credits to unemployed and poor, microfinance these days have come a long way.
Today microfinance products cover savings, payments, insurance and remittances. The market actors of microfinance may include banks, financial cooperatives, e-money issuers, payment networks, agent networks, insurance providers, microfinance institutions, and more.
The goal of financial inclusion is to develop financial markets that responsibly serve more people with more products at lower cost. Financial inclusion efforts today build upon the work of microfinance providers over the last several decades. We call them Micro Finance Institutions (MFIs).
A potato farmer spreading fertiliser. In order to work with ICT, especially on online platforms, it is essential that the MFIs and their agents have a good relationship with the farmers – Pic by Shehan Gunasekara
What began as the provision of loans to poor people for the purpose of building microenterprises has evolved into a global effort to provide poor people with access to a range of financial products and services. Research and experience demonstrate that, in addition to using credit, low-income people save, make payments, use insurance, and make use of a variety of other tools to manage their complex financial lives. Financial inclusion efforts seek to make these and other products available to everyone in a safe, cost effective, and convenient manner.
However, experience in delivering microfinance products suggests that they have the tendency to deviate from achieving their objectives. Studies show that poor have many difficulties in accessing microfinance products. These studies further shows that involvement in microfinance might drive the poor in to more dire situations, even losing the assets that were put on as collateral. Hence a reasonable research question to ask is “why do microfinance initiatives fail?”
Many studies have tries to answer this question and each and every study has come up with many answers. Despite the innovative product range that microfinance institutions offer I argue that the “transaction costs” is one of the main reasons for microfinance initiatives to fail. Let me try and justify my argument taking a microfinance loan as an example. My focus is on the farmers.
Small loans are more expensive to process than large ones because they take longer to process. Without employment history or collateral, microfinance loans require a more hands-on, time-intensive assessment to determine creditworthiness. Some microfinance loans require a guarantor who is employed in the government sector.
Most of the time contract employees are not accepted as guarantors in authorising microfinance loans. Hence farmers needs to spend lot of time findings a suitable candidate as a guarantor. Even still there is a high probability that the guarantor might be rejected depending on the income levels posed by the particular financial institution. There are significant transaction costs to the financial institutions as well.
Microfinance institutions (MFIs) usually send a representative to visit the farmer as part of this process, making the process even more challenging and costly in remote or sparsely populated areas. Once a loan is approved, MFIs often send loan officers to disburse loans and collect payments in person, which also adds significant expense when compared with the way traditional banks operate.
There are MFIs that lend on daily basis in places such as the vegetable market. Such instances the microfinance agent needs to go to the market place daily to disburse the microloan and to collect as well. Therefore the cost of administering the microfinance loan is high for the MFI as well.
As a result of the transaction costs the MFIs have to charge rates that are higher than normal banking rates to cover their costs and keep the service available. Transaction costs associated with the farmer might cause two things (1) the farmer might get discouraged and lean towards informal loans. Loans from the informal sector might charge more interest and might even ask for more collateral. At the end of the day there is a pretty good chance that the farmer might lose the collateral to the lender. (2) The farmer might give up seeking for a loan altogether. This might hinder the development, innovation and growth. For example, an entrepreneur who has a brilliant idea might never get a chance to implement since the transaction costs associated with getting the microloan is way higher.
Therefore the question is “how to minimise the transaction costs, whether it is for the farmer or the lender?” One of the ways where the transaction costs can be minimised is the application of Information and Communication Technology. Let me highlight some of the ways that ICT can be applied in to microfinance sector in order to minimise the transaction costs. Some of the ICT interventions mentioned below are in operation in other developing countries, especially in India and African region. Yet some ideas are results of my independent research work.
Finding inventors or business partners is a tough task for emerging entrepreneurs. There are plenty of entrepreneurs with brilliant business ideas but without proper financial backups. Online micro lending platforms try to directly connect lenders and entrepreneurs without any intermediaries. However in most cases these platforms works through intermediaries.
Having intermediaries have positive as well as negative consequences. The intermediary might charge a fee to connect the entrepreneur and the lender and this might vary from platform to platform. However, there might be situations where the cost of finding a lender by themselves is higher than paying a fee to the intermediary. In such a situations the service of an intermediary is justified.
Yet the recent trend of these online platforms is to eliminate the middleman and allow the farmer to get connected with the lender directly. These online platforms are popular and are really making a difference in countries such as India, Nigeria, Philippines, Italy, Australia, Russia, Hong Kong, and Paraguay. Examples for such platforms are Zidisha, Microgram, Cropital, and Kiva. These online platforms have success stories as well as failures.
As any online platform these also have many vulnerabilities. There is a good chance for people to get exploited unless act vigilantly. As suggested by research the chance of getting a loan for the first time is high. However developing a longer relationship with the moneylender could sometimes be problematic. Research studies have given many recommendations to overcome such failures. One such recommendation is to encourage the farmer to develop a longer-term relationship with the lender rather than trying to pitch a business idea.
As explained before, microloans comes with a stressed documentation process. Examples for some regular documents are: copy of the national identity card, copy of the birth certificate, copy of the deed, certification from the Grama Niladhari (GN), salary certificates, and proof of identity of the guarantors. This list might change based on the micro finance institution.
Most MFIs require photocopies of these documents submitted in person either to the agent or the office of the MFI. This is a 
tedious process, which might require the farmer to visit the agent or the office at multiple times increasing the traction costs. One possible way to work around this transaction cost is to promote digitised information.
All the MFIs work with e-mails. Most probably the agent of the MFI would have an e-mail address. Therefore it is quite possible that the information required for verification could be submitted through e-mails. In an ideal situation we would expect the whole loan approval process to be online. However Sri Lanka needs more time to achieve that.
Sri Lanka has implemented online platforms for some activities such as vehicle registration and application for pensions (this month). However MFIs are still not there. Therefore starting from the use of e-mails will be a good way forward. Many farmers use smartphones, at least one of their family members would probably use a smart phone. Therefore, it is possible to just take a picture (or may be scan it as a PDF) of a document and just e-mail it, eliminating the transaction costs.
One reason for MFIs to not work with online document is to do with the trust in the farmer. This is the main reason that MFIs require the farmer to bring in the original document when submitting the photocopies. But I believe that we are in an era where trust should not prevent from eliminating the transaction costs.
Microfinance loans are known for low repayment rates. This is one of the main reasons for the agents to go after the farmers in collecting the installments and interests. This has increased the transaction costs from the MFI’s point of view and requires having higher interests rates to cover these costs.
A microfinance loan has a repayment period and an exact date of the month to pay the installments. Once the installment date is passed an interest will be added. Hence missing an installment is cost to the farmer as well. Therefore it is possible to implement a mobile-based SMS alert system to remind farmers on the installment date.
There are farmers who do not pay the installments simply because they do not have money, therefore sending them alerts might not work. However, there are farmers who would miss the payment date because they have forgotten about it with much other work. In such situations, an ICT-based alert system, preferably an SMS sent to the farmer’s mobile phone reminding him the payment date, would generate positive results.
The idea here is eliminate the extra cost that a farmer has to bare if he unintentionally forgets the payments of the instalments. This however would not work if the farmer were broke. Research has shown some significant impacts of such ICT based alert systems especially when the microfinance loans are given to farmer organisations.
It is time to move away from the conventional way of working with microfinance loans. It is not necessary for the farmer to meet the lender in person. Online platforms allow the farmer to seek out more lenders at the same time it provides a lender with a range of choices.
With ICT innovations farmers should not be vising the MFI many times with photocopies, neither the MFI agent should visit the farmer. It is essential that online document submission and verification should be a central part of the microfinance loans. SMS alerts can prevent a farmer form incurring extra costs whenever the loan repayment is missed unintentionally.
In order to work with ICT, especially on online platforms, it is essential that the MFIs and their agents have a good relationship with the farmers. A well-established trust can basically help to internalise the transaction costs by implementing ICT interventions.
