Microfinance, a tool for economic empowerment

By Lindel Harlequin

A key philosophy of micro-finance is that small vulnerable businesses can grow to become big strong business when brought into a partnership with knowledge-based lending institutions. Besides the obvious benefits to Microfinance Institutions (MFIs) of having a portfolio of sound businesses, there is the other side of the coin, which represents the positive changes to the material lives of related entrepreneurs. Indeed, success of the business should be the only justification for the provision of financing.

Lindel Harlequin, General Manager, DFLSA Incorporated)
Lindel Harlequin, General Manager, DFLSA Incorporated)

To this end, the issue of economic empowerment indirectly becomes a concern of MFIs. Experts might never agree on definition “economic empowerment” but two key recurring themes will always be “sustainability” and “multiplier effect.”

In the relationship between MFIs and their clients therefore, more than just money needs to change hands. This need becomes clearer when one considers the basic stratification of micro business in terms of behavioral characteristics.

Quite often businesses classified as micro businesses represent persons from three broad categories (a) Involuntaries – those who stumbled into business as a result of a major life changing situation;  (b) Traditionals – influenced by friends and family already in business; and (c) Self-Actualizers – possess innate drive, stamina and business acumen.

Based on these behavioral traits, groups (a) and (b) tend to be satisficers – just doing enough to get by and keep the business afloat. They are also likely to keep borrowing the increasing amounts but tend to make little or no fundamental changes to their businesses to reduce vulnerability to economic shocks.  Actions such as broadening their product range or improving of business processes, service quality and marketing are rarely ever considered.

Another trend observed among such businesses was the tendency to spend most of business proceeds on the acquisition of non-business assets such as consumables and to a lesser extent, home repair and construction.   It should be noted that the term non-business assets is used here loosely to categorize those assets that have greater personal rather than business benefits.  Some MFIs such as DFLSA, accept household assets as collateral and as such there is a continuum between the two classes of assets.

Self-actualizers may intersect with groups (a) or (b) but will distinguish themselves in short order by their quick grasp of the implications of changes in their operating environment; keen eye for emerging opportunities; early adoption of new technology and good business sense – all qualities of a true entrepreneur.

Greater success rates are realized when due recognition is given to aforementioned stratification of micro-businesses.

The multiplier effect of investments (training, grants, technical assistance, gifts, loans) is usually 1 or less than 1 for traditionals and involuntaries given the tendency of such businesses to maintain the status quo. Offers of grants and technical assistance are often used to subsidize costs that would have normally been borne by the business. However, because there is low level of integration of the deliverables of such assistance into the day-to- day running of the business, there is no commensurate business growth. In fact what usually results is a perversion of the intended objectives, involving the siphoning off of the cost savings, now regarded as business surplus, for the acquisition of non-business assets.

The same thing happens in the case where financing is provided. Many MFIs can attest to the many clients who have been borrowing for years, and in many cases increasing amounts, while their businesses remained at the same level.

The unintended consequence of both of scenarios is an imperceptible transfer of the business equity from the business operator to the agency providing the technical or financial assistance. What is worse is that micro-businesses in this situation become very dependent on such agencies for their survival given the leakage of business surplus in the manner described above. In the event of any business interruption such persons could end up in a worse situation than when they first started borrowing.

The challenge therefore for MFIs and similar institutions is to realistically evaluate the “absorptive capacity” of their clients with their long-term interest in mind. This case is made very poignantly in Business Week December 24, 2007 under the caption, “Mexico: The ugly side of micro-loans.” The related section had to do with Compartamos, the largest non-profit micro-finance organization in Latin America. The traditional criteria for making the determination about absorptive capacity have mostly revolved around collateral, need or social considerations. These, while good by themselves, produce more realistic results when combined with considerations about management capacity and existing and potential liabilities.

If Microfinance is truly going to become a tool for economic empowerment it must be undertaken in an environment that provides fertile ground for capital creation and business growth among micro-businesses.

The dilemma is that some micro-entrepreneurs and financing agencies regard the new stoves, fridges, ovens, and motorcycles as evidence that economic empowerment has taken place whereas in fact, they only represent purchases indirectly financed through cost savings from grants or cash flow injections from financing agencies. In some ways this could be true but, it does not meet the strict requirement for sustainability and “multiplier impact.”

The common sense question is, if a micro-business suddenly had no access to finance could it continue to operate? This is a critical question that all micro-business should be considering. Micro-entrepreneurs generally judge their debt capacity by the weekly or monthly or monthly payouts, not by their total volume of debt. Thus, as long as the monthly payments are small they tend to rack up huge debts. This is the process which leads to the gradual reduction in business equity.

While all micro-business investments produce some degree of economic empowerment, it is often those managed by self-actualizers that are able to eventually make the transition from heavy dependence on external financial and other support for survival to the point where it becomes more an issue of strategy.
Self-actualizers often share some of the following characteristics:

1. A strong desire to borrow the minimum necessary to

implement a given project

2. A strong bias for value-adding, as against cosmetic

business investments

3. A clear understanding of the unit costs of their

product or service

4. A strong drive to succeed

5. A good understanding of their business environment

6. An eye for new opportunities

7. Openness to new ideas
Many MFIs employing sound loan appraisal techniques easily spot self actualizing entrepreneurs and have been actively doing so as such businesses have a greater likelihood of growing into large sound businesses.

Economic empowerment can therefore thrive and be sustainable where at least some businesses have as their primary objective business growth. In this way growing micro-businesses can pull the others along by becoming supplier of their goods and services. Given the relative size of micro-businesses they might not be able the necessary purchase volumes that would make them attractive to large, well-established suppliers hence, the role for various grades of intermediate-sized businesses.

The call for the focus on “entrepreneurs” as drivers of economic empowerment is neither new nor original, but timely. Nicola A. V. Virgil addressed some of these same sentiments in her book Public Policy in an Entrepreneurial Economy – Creating the Conditions for Business Growth. ISBN: 978-0-387-72662-5.

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