Nanofinance – The Legacy of Microfinance on the Way to Inclusive Banking

Microfinance as an industry does not get enough credit. While it is a type of lending, microfinance is much more than just an extension of credit to people in need. Microfinance, when executed with the consumer in mind, is a strong tool in facilitating financial inclusion and building long-term resiliency in the face of unexpected hardships for individuals and households around the world – in developed and developing countries alike.

Microfinance is associated with the name of a Nobel Peace Prize winner Muhammad Yunus, a Bangladeshi economist, who pioneered work in giving tiny loans to millions of poor people no commercial bank would touch — to destitute widows and abandoned wives, landless laborers, rickshaw drivers, sweepers, and beggars. As the NY Times reported in 2006, the Nobel Committee praised Mr. Yunus, who was 66 at the time, and the Grameen Bank (Bank for the Poor, as it titles itself), which he founded in 1983, for making microcredit a practical solution to combating rural poverty in Bangladesh and inspiring similar schemes across the developing world.

Yunus was one of the early visionaries who believed in the idea of poor people as viable, worthy, attractive clients for loans, said Elizabeth Littlefield, who at that time led the Consultative Group to Assist the Poor (CGAP). That simple notion has put in motion a huge range of imitators and innovators who have taken that idea and run with it, improved on it, expanded it.

It’s interesting that the effect of microfinance varies depending on where in the defined poverty group the beneficiary is. Moreover, wouldn’t be right to deny that microfinance projects in their waves and iterations did have very mixed results for financially challenged, excluded and highly disadvantaged groups, as well as economies of developing nations where extensive studies have been conducted in the past decade.

Findings of a study published by NYU almost 20 years ago still seem quite relevant when it comes to the effect of microfinance. While there was evidence to support the positive impact of microfinance on poverty reduction, especially on income smoothing and income increases, researchers expressed doubts about the actual capacity of MFIs to reach the poorest of the poor. Following were some of the key findings with regards to the effects of microfinance on poverty reduction:

  • Microfinance is not for everyone. Sick, mentally ill, and destitute are not good candidates for MFIs, but they should rather receive direct assistance;

  • Microfinance can be effective also for the poorest because there is no proof of either an inverse relationship between a client’s level of poverty and their entrepreneurial skills or minor inclination to save among the poorest;

  • It is not true that only people with an existing entrepreneurial activity can benefit from microfinance;

  • MFIs enable the poorest to improve their socio-economic conditions only if an appropriate program design and targeting are implemented;

  • Impact of microfinance can increase when it is provided together with other social services such as education and health.

What wasn’t explicitly expressed by researchers because FinTech wasn’t yet called FinTech, is that the most significant impact of microfinance is in a different dimension, it goes beyond creating a new class of financial products and selling it in a traditional manner. Microfinance redefined the way the banking system sees its customer base. What’s more important, microfinance as a concept paved the way for financial technology (and just technology) companies to enter the big world of institutional banking in a form that we see in 2018 (a potpourri of solutions all entering the finance world from the back door, and redefining consumer markets). Tech companies built a bridge into finance exactly as microfinance became a thing by targeting a very unusual demographic. Whole sectors have been invented and developed as a result of this new push to bring new potential consumer demographics into the light, connecting them to the world of financial services and products.

The world, in fact, has gone even further – all in efforts to expand the consumer realm – nanofinance could be the next big thing.

Through pay-as-you-go models, a handful of solar lighting companies have already used nanofinance to bring technologically advanced household products that many customers could otherwise not afford into thousands of homes in Kenya, Ron Bills, Chief Executive Officer and Chairman of the Board, Envirofit, shares through a an interesting piece written for WEF called Move over, microfinance. Here’s why the future of development is in nanofinance.

Nanofinance works for our customers by aligning with their consumption habits. In short, nanofinance brings the bank to customers. Coupled with a flexible service plan, its technology establishes a new communication channel that drives long-term adoption. Customers receive automated reminders about payments, and messages about equipment health, fuel levels, and usage. Because we know that success requires more than just having great technology, we also offer continuous training and other support, Bills says.

Going forward, it may be possible for nanofinance service platforms such pay-as-you-cook to help microfinance institutions collect loan payments using their infrastructure and relationships. I predict that we will no longer see people using microfinance loans to pay for energy products. Instead, household goods and services providers will partner with pay-as-you-go nanofinance companies to make small, flexible household loans for more products that people need and want.

Nanofinance has the potential to go from servicing household energy systems to becoming a standalone finance channel. It is the next evolutionary step in sustainably serving low & middle-income households and will help build stronger relationships with them by offering more channels for customer care and assistance. With nanofinance, social enterprises can reach more underserved markets to help more people live well. – Ron Bills, Chief Executive Officer and Chairman of the Board, Envirofit

The largest financial institutions in certain developing nations are already actively exploring nanofinance. The Bank of Ayudhya (BAY), Thailand, has branched into nanofinance, aiming for loans outstanding to reach 170 million baht (~$5.45 million) by the end of 2017. Krungsri Consumer, the unsecured lending arm (unsecured loans) of Bank of Ayudhya, introduced Tao Kae Tan Jai, a revolving nanofinance loan product, in September 2016. Borrowers were charged 36% interest, the Bangkok Post reported. On the bright side, borrowers who had good repayment track records for more than six installments were offered 10% cash back on interest. In addition, for at least one year, they receive an additional credit line of up to 100% and cash cards that can be used for cash advance withdrawals at all ATM terminals.

While nanofinance can be considered a type of microfinance, it is a significant step ahead for the industry in fighting unexpected negative outcomes of microfinance, which has been proven by numerous studies to have very mixed outcomes. Nanofinance emerged out of the learnings of how loan sharks were using predatory practices to drive individuals and households into deeper financial crisis. Some of the most important distinctive hallmarks of nanofinance is that the success of the facilitating party is rooted in trust and relationships in very localized communities. Nanofinance aims to alleviate emergencies in one’s life without the goal of maximizing the profit in the shortest term.

While nanofinance is still a high-risk financial product, some of the reasons researchers believe this development of microfinance is expected to be the next important facilitator of inclusion include:

  • The nanofinance schemes in developing countries aim to tackle the problem of informal loans, which exploit legal modern day sharking and predatory activities;

  • The pitfall of informal loans is the borrowers’ failure to assess their own debt repayment capacity, while taking into account the high and swiftly rising interest rates of loan sharks. This eventually leads to a vicious cycle of rolling over debts;

  • Because of the more flexible process in credit issuance, nanofinance will be probably prone to steer borrowers from loansharking.