Cashflow lending: Towards more appropriate micro-enterprise loan products

There are two basic microfinance loan products – group loan and individual loan. Group loan scheme is used for very poor clients for them to have a support group, which also functions as the pressure group for defaulters, and to develop financial discipline necessary for a sustained financial access.  Individual loan scheme most often is provided for the “entrepreneurial poor” who has the capacity to venture into income-generating activities which we can call “livelihood activities”. These are simple buy-and-sell activities where the clients buy in bulk, place a mark-up and sell the products in the neighborhood or in areas with high foot traffic. Most of these activities are done by individuals and sometimes assisted by other members of the family including children.

 At certain point, some of the more enterprising among the clients move up and increase their volume of trading. Some enterprises evolve from livelihood to “micro-enterprises” – economic activities that exhibit growth potentials, that when given the right inputs and resources can become big. To sustain the growth, entrepreneurs have to transform themselves from a jack-of-all-trades to  managers with knowledge and  skills in inventory control, marketing, finance, and the other requisites of an enterprise. As the operation goes more complex, profit also increases that further motivates the entrepreneur to go on further.  Seizing the opportunity is the name of the game as the entrepreneur takes advantage of bulk sales, consignment from suppliers, and other marketing arrangement and balancing these with fast turnover of goods through credit sales, promotions and other schemes that ensures sales.

 At this point, one of the most important factors is cashflow.  Start-up and growing enterprises need cash to cover inventories, operating expenses to pay suppliers, workers and lenders.  The entrepreneur may need big amount at one time, but he can also have big cash inflows in another time which allows him to immediately pay back his loans. Effective cashflow management is one of the marks of an entrepreneur, and to have it, the entrepreneur need a standby source of cash, or credit that he can access every time there are cashflow concerns.

This is where the mismatch happens. Most of the loan products of MFIs are inflexible and still in the context of developing financial discipline as if  entrepreneurs are first-time borrowers. Despite the track record developed by entrepreneurs who are long-time clients of MFIs, they still has to contend with the standard loan features such as fixed amount, payments are in equal installments and made at regular intervals. The worst feature is at certain amount, hard collateral is required, limiting the amount that can be availed by the entrepreneur. The option for the entrepreneur is to borrow small amounts from different lenders to cover for his total cashflow requirement. This I think is a missed opportunity for MFIs.   With minimal skills in assessing enterprises, credit staffs are limited to determining the value of the collateral as the basis for the loan amount.  The danger of falling into the collateral lending trap was emphasized in the previous article.

 A more appropriate loan product would be cashflow-based with the following main features:

  •  credit-line type of loan with a maximum amount based on the historical data of cash requirement;
  • risk covering  is not  limited to hard collateral but a combination of  real estate, chattel, inventory and even collateral substitutes like savings;
  • fast processing of  draw down from the  approved amount;
  • business development services to enhance the skills of the entrepreneur are a must. 

Providing appropriate loan product should also be coupled with business development services to develop the soft skills of the entrepreneur. These skills will enable the entrepreneur to transform the economic activity from a livelihood to growing micro-enterprise and minimize risks as well.

The main skills that should be developed include but are not limited to the following:

  •  Basic management skills which covers how enterprises are systematically run. This involves skills in planning both for the short and long term; organizing different functions and delegating them to hired workers; and coordinating the overall operations.
  • Marketing skills which covers understanding the needs of the clients and aligning the products, doing market research, price setting and promotion.
  • Financial management and accounting to ensure that the funds of the enterprise are separated from the personal funds of the entrepreneur. Record keeping to develop track record for the formal financial institutions specifically for MFIs.

 In the end the assistance is an investment that will be mutually beneficial to both the MFI and the micro-enterprise client.

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CATEGORIZING MICROFINANCE LOAN PRODUCTS

ImageMarket research is now an indispensable tool for MFIs in enhancing their products and services. The emerging trend is now far from the previous one-size-fits-all financial products that has been the cornerstone of microfinance success for several decades.   Group loans are basically reserved for first time borrowers that have yet to establish track record of repayment and those without collateral. For those who have been accessing loans from MFIs for several years, and who were able to move up to the income ladder, financial products that respond to their specific requirement are what they needed.

MFIs should respond to this reality to be able to retain their existing clients and to reach out to other clients. Categorizing products and services will help MFIs rationalize its offering and be able to look at what is lacking.

Loan products can be categorized into two main purposes: for income-generating economic activities and non-income-generating activities. In most Asian countries, the income-generating activities can further be divided into two: enterprises and agricultural production.

Enterprises on one hand, refers to the economic activities of microfinance clients mostly trading in nature. These includes, vending, buy-and-sell, small variety store and the like.  Other economic activities involving simple production skills also fall in this category like handicrafts, preparation of foodstuff and the like.  Activities with growth potentials can be provided not only with loans but also with technical assistance for it to move up from micro-enterprise to small and medium classification, where a more organized and systematic  management skills is needed.

Agricultural production on the other hand, refers to economic activities related to the production of crops, poultry and livestock and even fishery particularly fish culture. The production process from planting to harvesting is the main focus of financing. The risky nature of agricultural production is the reason why banks shy away from this sector.

The non-income-generating needs also known as consumption needs of the clients can also be further categorized into two: life cycle needs and emergency needs.

Life cycle needs refer to the events in one’s life where bigger amount of money is needed. This includes expenses for birth, education, house building or improvement, acquiring assets like land, marriage, old-age pension, death, and other events determined by our tradition and culture.

Emergency needs refer to unexpected expenses brought about by natural calamities like typhoons, floods, earthquakes and even man-made calamities and personal emergencies like sickness, accidents and the like.

These general categories rationalize an MFI’s list of products and services. Providing the clients with wide array of products that can cover their specific needs will surely develop client loyalty. It will ensure not only the sustainability of the institution but the improvement of standard of living of the client as well.

Developing Agri-Microfinance (AMF) Loan Product

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Developing agricultural microfinance (AMF) addresses two main issues in development finance: first, to ensure that small farmers have access to credit for production expenses; and second, to address the risks involved in agricultural production. Risks is agricultural production  is so high that most formal financial institution do not venture in the agricultural sector, leaving  government  banks and the informal money lenders to serve this sector. Developing AMF products involved several activities:

  •  The Market Study includes market-understanding research to determine the features of the loan products. It will also provide information of the specific agricultural commodities that can be financed. It also includes a risk profile identifying various risks related to the commodities and the coping mechanisms to address the risks.
  •  During the Product Development Workshop,  information from the market study are used to develop the “product architecture” – the features of the loan product fit to the needs of the clients and the production cycle of the  commodities identified for financing. It shall also review of the loan process.
  •  The Pilot testing is the phase where the product prototype designed during product development workshop will be implemented in a limited scale, say a branch, to check its applicability. Monitoring and coaching sessions are done during this period to check the development, the variance in the features and processes and other observations that will enhance the product.  Refinements in the features and the process can be done during this phase.
  •  The final phase is the Mainstreaming where the tested products will be installed in all operating units of the financial institution.

Based on our experience, AMF loan products are appreciated by the farmers because the loan term is fit to the production period and the harvest season, and they understand the production cost of each agricultural commodity. On the part of the credit staff, the commodity profile assisted them in speeding up the loan appraisal process. It became easier for them to determine loan amount based on the production activities in the commodity profile.

In mainstreaming AMF, there are several pointers that have to be strictly observed.  Agricultural production should be treated as a separate economic activity that requires a specific loan product. Agribusiness or enterprises that are not directly related to the production process like trading, provision of inputs and the like should be categorized under enterprise or business loan and not as part of AMF. Portfolio management should prescribe percentage allocated for AMF, taking into consideration the suitability of the area to agriculture (irrigated or not), the frequency of natural calamities and other factors.

Cambodia MFIs: At the forefront of agricultural finance

The government of Cambodia is in full-swing mobilizing resources to upgrade the country’s infrastructure in support of agricultural development. Roads, ports, irrigation and other support facilities are fast-tracked to reach the target of making Cambodia one of the main rice-exporting countries in the region, in the league with neighboring Thailand and Vietnam. Resources for these upgrading projects are sourced from a mix of loans from bilateral and multilateral agencies and from private investments.

In the absence of a massive government financing program for agriculture, resources for the production phase remains with the informal moneylenders and the microfinance institutions. For small farmers, these two sources are the most accessible and relevant to their needs. Of the 32 MFIs licensed by the National Bank of Cambodia (NBC), almost half has loan products for agricultural production. It is estimated that more than half of the $732 million outstanding loan portfolio of the microfinance industry is invested in agricultural production and other agriculture-related economic activities, benefitting 1.1 million clients nationwide.

The MFIs have also started re-designing their loan products. Most are still having the traditional group or individual loans, but some have already fine-tuned their products, infusing features that fit to the needs of the farmers. In a project funded by European Union (EU) and the Agence Francais de Developpement (AFD), MFIs are assisted to develop agricultural-microfinance (AMF) loan product. The loan product will specifically be used for agricultural production and agriculture-related economic activities.

The contribution of the MFIs in the development of agriculture is also part of the poverty reduction goals of these institutions. While most MFIs started as non-government organizations and projects of development agencies, social mission is considered as the ultimate mandate even as commercial investors are gradually becoming the main source of funds.

The situation in Cambodia where the private sector is the main providers of funds is better compared to other countries where the government is heavily involved through special government-owned banks. With a subsidized lending program, inefficiencies are shouldered by the taxpayers and also developed dependency among the farmers.