Dr. Salehuddin Ahmed
Managing Director
Palli Karma-Sahayak Foundation (PKSF)
Dhaka, Bangladesh

This paper is intended to further the Microcredit Summit Campaign’s learning agenda. Translation, printing and distribution of this paper has been made possible by a grant from the Grameen Foundation USA. The opinions expressed herein are those of the author and do not necessarily reflect the views of the Microcredit Summit Campaign or Grameen Foundation USA.

Table of Contents
Executive Summary
Section 1 Rational for an autonomous microcredit fund
   1.1 Need
   1.2 Major objectives of MCFs
   1.3 Impact on the poor and the poorest and achieving the Microcredit Summit's goals
Section 2 Institutional Structure of the Funds
   2.1 
   2.2 Governance Structure 
   2.3 Management
   2.4 Autonomy
Section 3 Funding
   3.1 National MCF
   3.2 Sub-Regional MCF
   3.3 Market Sources of Fund
Section 4 MCF Policies for funding partner microcredit institutions (MCIs)
   4.1 Strategies of credit programs of MCF
   4.2 Salient Features of the Credit Programs of MCIs
   4.3 Eligibility criteria for Funding MCIs
   4.4 Accounting and Auditing Principles
   4.5 Managing the Savings of Beneficiaries
   4.6 Default Management
   4.7 Performance evaluation of MCIs
Section 5 Implementation Strategies
   5.1 Management Information System (MIS)
   5.2 Human Resource Development
Section 6 Institutional Development
Section 7 Regulatory Framework
Section 8 Interface Among Sub-regional MCFs, National MCFs and National MCIs
Section 9 Concluding Remarks
Section 10 PALLI KARMA-SAHAYAK FOUNDATION (PKSF) : THE APEX NATIONAL MICROCREDIT FUND IN BANGLADESH (Case Study)
   10.1 Objectives of PKSF
   10.2 Operational Strategy of PKSF
   10.3 Legal Structure of PKSF
   10.4 Organizational Structure and Membership
   10.5 Programs
   10.6 Program Implementation
   10.7 Fund
   10.8 Achievements of PKSF
   10.9 Sustainability of POs and Role of PKSF
   10.10 Some Lessons from PKSF Model
Section 11 FONCAP S.A.-FONDO DE CAPITAL SOCIAL ARGENTINA (Case Study)
   11.1 The rationale for creating the fund
   11.2 Institutional Structure of the fund
   11.3 Funding: how to forge partnerships and obtain funds while ensuring autonomy
   11.4 Policies for selecting partner MFIs
   11.5 Implementation strategies
   11.6 FONCAP Portfolio (November 2000)
Section 12 LOCAL INITIATIVE DEPARTMENT IN BOSNIA-HERZEGOVINA (Case Study)
   12.1
   12.2 Implementation Arrangements
   12.3 MFI Performance
   12.4 Institutional Capacity Building
   12.5 Legal and Regulatory Reform
   12.6 LIDs Portfolio Performance (December 31, 1998)
   12.7 Future Perspective

Executive Summary

In order to fulfill the Microcredit Summit goal of reaching 100 million of the world’s poorest¹ families by the year 2005, several measures must be taken to ensure that more resources reach the poorest in cost-effective ways. The mechanism of channeling funds, especially government and donor funds, to microcredit² institutions through autonomous apex funding organizations can prove to be efficient, quick and cost effective. Therefore there is a need to create such microcredit funds (MCFs) at the national and sub-regional level. MCFs can perform two major functions: financial intermediation and development of sustainable microcredit institutions. The institutional structure of such microcredit funds has to effectively resolve the legal/ownership issue, governance issue, management issue and autonomy of the MCF. The ownership structure should include a judicious mix of the state, civil society and private sector. In order to keep the fund free from political interference and bureaucratic tangles, the autonomy of the fund must be recognized by the government and all other stakeholders. It must be remembered that autonomy does not come as a 'gift from heaven;' it has to be derived from the political commitment of the government. This is a difficult, but not impossible task, as the case study of Palli Karma Sahayak Foundation (PKSF) in Bangladesh shows. A major advantage of autonomous microcredit funds is their ability to screen and monitor a large number of microcredit programs (MCPs) according to same standard criteria, compared to often inconsistent 'ad hoc' evaluations of individual MCPs by donor and government agencies. Funding sources of MCFs may include the government, donor agencies, international financial institutions, the central bank and commercial banks within a country. The 'necessary' condition of funding is that the government of a particular country should commit its own resources, thereby making a firm pledge to help the poor through an autonomous microcredit fund. The microcredit funds should have pragmatic standards and procedures for evaluating the partner organizations in such areas as: accounting and auditing, default management, management information systems, human resource development and sustainability. The case studies of PKSF in Bangladesh, Fondo de Capital Social (FONCAP) in Argentina and Local Initiatives Department (LID) in Bosnia- Herzegovina bring out the salient features of microcredit funds. Both the "process" and "output" aspects are briefly analyzed in the three case studies that are diverse in nature and in geographical setting. However, there are some common features present in the three case studies, namely: a commitment of the government and other stakeholders to microcredit operations, some degree of autonomy of the funds, quick and cost-effective implementation systems, good management and reporting systems and evaluation of partner organizations based on performance. No system is perfect, and the preconditions to set up a system may not be perfect, but one must make a bold decision to introduce an innovative practice like that of a microcredit fund which has already proved to be the best practice in some places on the globe. The attacks on autonomous funds have already been challenged by realities in the field. These apex funds are proving their enormous potential to help the forgotten poorest people on earth.

Section 1. Rationale for an autonomous microcredit fund

Not long ago Razia Begum of Charfashion Thana in Bhola district of Bangladesh could hardly manage three meals a day. Now the 35 year old housewife earns more than she needs a month and dreams of prosperity. A mother of six, Razia once had little idea about primary health care and sanitation. Now the members of her family use sanitary toilets and consult doctors when they fall ill. When her children study at night, Razia too reads and writes with them. "I could never imagine that I would ever be able to sign my name. It has been possible thanks to Family Development Association (FDA). FDA has changed my life," said a gleaming Razia who weaves household articles with bamboo and cane. Her husband also helps her in her work. Goods and articles made by her are in demand in her area because of their quality. She never goes to market. Instead, buyers come to her house for the items she makes. It all began eight years ago with a loan of Tk. 3000 (US$60) from Paribar Unnayan Sangstha (FDA), a local non-government organization affiliated with Palli Karma-Sahayak Foundation (PKSF). The funds of PKSF, the world's largest apex microcredit funding institution, go to NGOs, cooperatives and the government sponsored ANSAR VDP Bank. PKSF has 174 active partner organizations (POs), including BRAC, PROSHIKA and ASA in 63 districts of the country while the total number of its beneficiaries is about 1.8 million. PKSF not only provides loans to its POs, but also imparts training to their staff members and provides them with institutional development services for better loan management. PKSF also provides interest free loans to its POs for buying computers, motorcycles and bicycles.

Microcredit has proved to be an effective tool for poverty alleviation by creating opportunities for the poor to gain access to financial resources and services. In most of the countries around the world donors, business houses, private individuals and governments are providing funds to various domestic microcredit institutions (MCIs) to carry out microcredit programs (MCPs). In order to fulfill the Microcredit Summit goal of reaching 100 million of the world’s poorest families with microcredit by the year 2005, steps must be taken to ensure more resources to promote microcredit and to ensure that those resources are provided to MCIs in cost-effective ways. The present mechanism of channeling funds to MCIs, especially government and donor funds, has proved to be inefficient. The total cost of providing funds directly to microcredit programs (or "retailers") is usually high when the cost of feasibility studies, appraisal missions, monitoring, evaluation, reporting and so on are included. This is particularly true in cases where the funding agency does not have a permanent office or adequately trained personnel near the MCP being funded. MCPs require flexible, user-friendly, consultative and fast-moving processes located near their areas of operation. As a result of the high costs involved in providing funds directly to MCPs, as well as the high costs incurred by many MCPs in receiving and administering these funds, a relatively small amount of these funds are actually provided as loans to the poorest. It is very difficult to give figures on how much donor funds go to the poor. Some estimates may be made. About 51% of CGAP's core fund reached the poorest as direct lending in its first 3 years of operation and the rest was spent on capacity building, technical assistance, conferences, etc. Another estimate made regarding USAID's fund: a maximum of 25% of the total funds reached the poorest. About 10% to 25% of donor funds actually reach the poorest, while the rest is spent on administration, overhead, training, institution building and consultants (Prof. M. Yunus "How Donor Funds Could Better Reach and Support Grassroots Microcredit Programs Working Towards the Microcredit Summit's Goal and Core Themes," Abidjan, June 1999). Therefore, there is a need to create autonomous and cost-effective microcredit funds (MCFs). In a large country or in a country where MCPs have great potential, national funds can be created. In small countries where MCPs are not well developed, sub-regional funds can be created³.

1.2 Major objectives of MCFs

A major advantage of autonomous microcredit funds is their ability to screen and monitor microcredit programs (MCPs) according to standard criteria, compared to often inconsistent 'ad hoc' evaluations of individual MCPs by donor and government agencies. Funding and support based on uniform standards create a level playing field. Standard monitoring requirements also contribute to more professional MCPs which may be converted to professional microfinance institutions for poverty eradication. It may be interesting to note how PKSF played the role of both financial intermediary and market developer.

i)   In the beginning, PKSF targeted only small NGOs and heavily invested in their institutional development with the adoption of a conservative loan disbursement approach. Within three years the small partners of PKSF were capable of attracting clients of three big retailing organizations. They quickly responded to this newly created competitive environment. The Bangladesh Rural Advancement Committee (BRAC) started reorganizing their program with more focus on sustainability during 1991-1994. Proshika restructured its microcredit program in 1994. It introduced savings products to its clients only after getting involved with PKSF in 1996. The Association for Social Advancement (ASA) and PKSF have built an excellent partnership since 1992. Following all out cooperation from PKSF, ASA quickly restructured its credit program. ASA grew with PKSF and is now one of the most successful MFIs in the world.

ii)   By 1996 PKSF was able to create a standard for the microfinance sector in Bangladesh. It not only promoted Grameen’s financial technologies, but also accommodated other technologies. Most of the donors agreed that their partners should go to PKSF to expand their MCPs. The World Bank played a key role in this respect. BRAC & Proshika also applied for funds from PKSF. After a rigorous management audit, they were found to be eligible to become PKSF’s POs. It should be mentioned that both gave high value to PKSF’s suggestions as they became convinced that their institutional strength would be further enhanced if they followed PKSF’s instructions. This was not a trivial task of course; PKSF had to earn their respect.

The rational emphasis recently placed by many donors and governments to fund "institutions" rather than "ad hoc projects" is in line with the arguments put forward for creating autonomous microcredit funds.

Through 189 POs, PKSF has, to date, disbursed more than US$165 million to over 2.13 million borrowers. Ninety percent of these borrowers are women. PKSF targets people who have up to 0.5 acre (0.2 hectare) of land or a total asset equivalent to the value of 1 acre of arable land (0.4 hectare). All the beneficiaries of PKSF are below the poverty line (2122 k.cal per person per day) and as such all of them are among the 'poorest.'

The core objective of the national and sub-regional MCFs should be “reaching the poor and poorest with financial services through sustainable MCPs under viable institutional arrangements.” While the national and sub-regional microcredit funds (MCFs) may engage in providing a number of diverse services to promote the development of MCPs in their respective areas of operation, two major functions should be focused on: financial intermediation and development of sustainable institutions.

The two major functions mentioned above are expected to produce two important outcomes:

(i)   The microcredit fund (MCF) will mobilize funds from governments and donors, in the form of loans and equity grants, and provide these funds to local MCIs to finance grassroots MCPs. These MCIs must be autonomous and outside direct control of the government and must be engaged in retailing loanable funds to the poor and poorest.

(ii)   The “intermediation role of the MCF will therefore strengthen local organizations’ capacity to provide a sustainable system of financial services for the poor and poorest. This will develop the efficiency and competitiveness of MCIs to provide quick, efficient and cost-effective credit. They will be sustainable, while the ad-hoc and rootless organizations will wither away. At a more mature stage, the MCF can mediate between the MCIs and private capital markets by providing a credit rating of MCIs and securitization of MCI portfolios.

Some researchers argue that in the absence of any viable MCI or MCP, apex organizations will not be viable. Therefore, they continue to hold the view that several other mechanisms may be better than apex organizations as instruments for the development of sustainable retail microfinance organizations. Both arguments hinge on the operation of regulated financial markets rather than independent, autonomous and competitive MCIs. Apex organizations will help create new MCIs and help them to attain financial sustainability. The fact that in some countries microfinance has been quite successful without strong apex organizations (like Indonesia), does not negate the necessity of an apex. While BRI in Indonesia has been successful in microfinance, their programs are rarely targeted to the poorest and their clients are not necessarily directly comparable to those of other organizations which are specifically trying to reach the poorest. Therefore, the need for apex funds for providing microfinance services to the poorest is relevant for all countries willing to work towards the Microcredit Summit’s goal.

Some analysts argue incorrectly that PKSF started its operation in an advanced microfinance market endowed with a developed retailing capacity. In fact, there was no single MFI that was even reasonably close to attaining operating sustainability in 1990 other than the Grameen Bank. The total portfolio of NGO-MFIs was 0.4 billion taka (US $7.4 million) in 1990. The quality of this portfolio was far from acceptable. BRAC, now the biggest NGO-MFI in Bangladesh, was struggling to devise an appropriate lending technology in the early ‘90s. It was experimenting with village organizations for delivering microcredit, a strategy which it abandoned in 1993. Proshika, another large NGO-MFI, had a microcredit program which was charitable in nature until 1994. ASA, one of the finest MFIs in the world, did not have a microcredit program until 1992. The fourth largest MFI in Bangladesh, TMSS, had a portfolio of Taka 0.2 million (US $3,714) in 1991 with less than 400 active clients. Moreover, about 90% of today's NGO-MFIs did not have any microcredit program in 1990. A good number of them did not even exist. This was the retailing capacity of the NGO sector in 1990, the same year PKSF was created.

The following is further evidence of the weak state of retailing capacity in the microfinance sector of Bangladesh in the early ‘90’s. Total portfolio of NGO-MFIs was Tk. 0.4 billion (US $7.4 million) in 1990. The size of this portfolio has increased by 4500% in the last 10 years. It is interesting to note that this portfolio grew by only 900% within the first half of '90s. This shows that the boom in the microfinance sector of Bangladesh took place in the '90s and was especially profound in the second half of the '90s.

The following table shows growth in the number of PKSFs partner organizations. It also reflects the weak state of the retailing capacity of the sector in the early ‘90s.

Using the experiences of PKSF, we may list the following conditions which, among others, should be fulfilled in order to have a good MCF:

a)   Governments of developing countries must adopt measures to promote microfinance as a long-term public policy. Continued government support of various types is an essential condition for a successful domestic apex organization.

b)   Donors must act in a concerted manner to promote microfinance with the goal to make it sustainable.

c)   The apex organization should be designed from the very beginning to promote the microfinance sector with a long term commitment along with a clear vision of becoming sustainable within a reasonable period of time (maybe 12 years). This vision must be reflected in its cost structure. For a thin microfinance sector, the apex organization will also be thin. It should also take special care in developing the right attitude of its own human resources from the very beginning.

d)   The donors should disseminate information about best practices to the domestic apex organization. This gives the apex organization an opportunity to develop its own lending technology so that it owns it.

e)   An established microfinance market is not a necessary condition for higher probability of success of a domestic apex organization. In every developing country (even in some of the developed countries). The need for microfinance is huge. The apex organization will adopt market development as an integral part of its financial intermediation role from the very beginning.

f)   The apex organization’s lending technologies should give MFIs enough time for generating surplus funds, part of which may be used for innovating new financial products. No grant should be given in this regard. The result will be a more cost-effective way of innovating new financial products for the poor.

g)   The domestic apex organization should be in clear agreement with its partner organizations (POs) regarding the POs' institutional and financial sustainability within a reasonable period of time.

The efficacy of an apex organization like PKSF can also be seen from the point of attaining financial viability by its partner organizations (POs). It will be pointed out (in sec. 1.3) that PKSF has achieved financial viability. Two main indicators - operating self-sufficiency and financial self-sufficiency - were used in a study by the World Bank team in Dhaka in April 1999 to determine the financial viability of 21 randomly selected POs. These POs were enlisted by PKSF in different years starting from 1990. The financial reports and program data of all POs for the financial year 1997-98 have been used for the analyses. The sizes of these POs vary; the number of borrowers ranges from 1701 to 72,000. Except for the smallest PO (with 1701 borrowers), all other POs have been found to be operationally self-sufficient, that is, they covered operating expenses from their income of microcredit. Similarly, 18 of 21 POs have been found to be financially self-sufficient, that is they have been able to fully cover their operating and financial expenses through interest on members' savings (at the rate of 6% per annum), through the cost of borrowing from PKSF (at 3-4.5% per annum), and through the provision of bad-debt. The three that could not achieve financial self-sufficiency had a small number of borrowers, ranging from 1701 to 3613.

1.3 Impact on the poor and poorest and achieving the Microcredit Summit’s goals

MCFs are closer to the grassroots organizations. Funds provided by MCFs are cost-effective and can reach the poor and the poorest without any leakage. Out of every dollar, it is expected that nearly 100% of it will go to help support institutions serving the poorest. Since the ultimate borrowers will get the credit in a cost-effective manner, the borrowers will be able to more quickly use these on various income-generating activities (IGAs) and thereby increase their incomes. PKSF has demonstrated a highly satisfactory performance with regard to financial viability. It has consistently covered its operational expenses from the service charges (which range from 3 to 5% per annum) it earns from wholesaling funds to its partner organizations. Until financial year 1999, PKSF had succeeded in keeping general growth and administrative expenses at less than the growth in income, resulting in rising operating margins. In 1999 total operating expenditures were 70% of the total income from service charges. PKSF has been able to fully cover its operational expenses and financial expenses (interest on loans taken from various sources, provision for debt servicing, and provision for bad debt) from its total income.

PKSF has utilized the entire credit fund received from various sources for on-lending to its POs. PKSF has not spent anything from its capital fund; rather, it has been transferring its surplus income to its capital fund. For example, in 1999 Tk. 183 million (US$ 3.6 million) was transferred to the PKSF capital fund after all operational and financial expenses (including a loan loss provision of US$ 0.77 million) were met. This shows that an apex organization can channel the maximum amount of funds to the poorest people at the grassroots level. Studies of such MCFs in Bangladesh (PKSF) have shown that it has helped improve the social awareness of the poor (Alamgir 1997). It is expected that due to the operations of the MCF for on-lending through the MCIs, there will be improvements in asset levels, savings, housing patterns, occupation, education, health status and financial self-reliance of the microcredit borrowers compared to those of non-borrowers in a given area.

Another very important impact is in gender sensitization for poor women in rural areas. A substantial portion of the MCP’s borrowers are women. The credit received by women not only makes them active economic agents but also makes them socially important. This ‘awareness’ on the part of the women is reflected in the increasing number of women participating in other development activities and in local council elections (like Village, Union/ Panchayet and sub-district councils). The three essential elements of social mobilization, economic integration and political participation of the poor are facilitated by MCPs, among others.

From the above analysis, it is clear that creating MCFs at national and sub-regional levels will help achieve the following core themes of the Microcredit Summit by the year 2005:

• reaching the poorest families (with MCPs).

• reaching and empowering women.

• building financially self-sufficient institutions (MCIs).

• ensuring a positive measurable impact on the lives of clients and their families.

The ultimate test of a MCP is its impact on the borrowers. This impact may be direct (primary), such as impact on income and employment, or indirect (secondary), such as improvements in education, health and housing. Some selected indicators for evaluating the impact of a MCP on borrowers are:

(i) Economic indicators for current gains (income, food and nutrition intake, housing); (ii) Indicators of long-term material gains (land); (iii) Proneness to crisis; (iv) Indicators of social gains (e.g., education, sanitary conditions, drinking water).

Section 2 Institutional Structure of the Fund

MCFs that can facilitate fulfillment of the Microcredit Summit goal can be put into two broad categories. First is an autonomous national fund, and second is an autonomous sub-regional fund. The legal/ownership structures of the two types vary primarily in that the first works within a national boundary (and operates within a national legal framework) while the second operates across national boundaries and works within a broad framework of consensus among different countries.

(a)   The government may set up such a fund under a special legal enactment ensuring full autonomy. One may argue that MCFs under government patronage will not work. While there is some truth in the statement, it must be pointed out that without government support a national MCF will not be as robust as it should be.

The idea is to mix state, civil society, and private initiatives with the ‘core requirement’ being autonomy. We shall come to this point later.

(b)   Donors and private financial institutions may form a consortium and create a MCF. However, this may require a guarantee from the government to allow the donor money to come to this fund on a loan basis. Moreover, a legal entity must be created either under an existing law or through a special enactment by the government. It is easier if the MCF is set up under an existing law such as (i) Voluntary Societies Act, (ii) Trust Act, (iii) Societies Registration Act, (iv) NGO Act, or (v) Financial Institution Act. If such laws do not exist, or if they exist but the proposed MCF cannot be set up under these laws, then there will be the issue of enacting a special law, a lengthy procedure and one for which political commitment may be lacking. Fortunately, each country will likely have some feasible options under existing law if there is a consensus among the government, donors, MCIs, and other stakeholders.

(c)   The government may set up the MCF under an existing Company’s Act and the MCF may be set up as a ‘not for profit’ company by the government. This is how the Palli Karma-Sahayak Foundation (PKSF) in Bangladesh was established. The government used the Company’s Act of 1913.

A sub-regional MCF can serve a number of surrounding countries, for example: Sub-Saharan African countries, West African countries, Central American countries, or Pacific Island Nations. Since such MCFs will cover several countries, legal coverage under a specific national law may not be feasible. One alternative may be to set up a MCF under the auspices of an inter-governmental organization such as the Asian-Pacific Development Centre (APDC) in Kuala Lumpur for small countries in South-East Asia; Centre on Integrated Rural Development for Asia and the Pacific (CIRDAP) in Dhaka for countries of the Pacific Island nations; and Centre on Integrated Rural Development for Africa (CIRDAFRICA) in Arusha for countries of that region. I use these examples because these organizations already have the member countries’ support for programs on poverty alleviation and MCFs created under these organizations could reach the poorest in their respective member countries.

Sub-Regional MCFs can be formed as an initiative of sub-regional networking organizations which may already exist for the purpose of exchanging information and technical knowledge on regional development issues. If such organizations do not exist, then organizations like the Consultative Group to Assist the Poorest (CGAP), Friends of Women’s World Banking (FWWB) and even the Microcredit Summit Secretariat could help launch discussions with the respective countries about setting up such a fund.

The governance structure of the proposed MCFs should be based on three principles: a) Autonomy b) Accountability to the stakeholders, and c) Efficiency and cost-effectiveness in management.

A pair of policy-making bodies such as a (1) General Body and Governing Body; (2) Governing Council and Executive Committee; or (3) Board of Trustees and Working Committee should be formed. In each pair of the above bodies, the first should be a representative body of about 25 members responsible for setting broad guidelines for operations, approving budgets, auditing reports, and adopting strategic policy options. The second body in the pair should be responsible for the management and administration of the affairs of the MCF in accordance with the mandate and rules set by the first body. The second body should consist of a relatively small number of people, preferably 10 members and should meet as frequently as required, while the first body should meet once or twice a year.

In order to preserve the autonomy of the MCF, a crucial issue is the political will of the government reflected in its commitment to poverty alleviation through microcredit. The government will possibly support other interventions like health, education, infrastructure development and social mobilization for poverty alleviation. Because microcredit has proved to be an important and effective tool for poverty alleviation, support for MCPs should be attractive for any government. Having political support, and a set of dedicated and highly committed persons with knowledge of microcredit from both the government and private sectors will help make MCFs truly autonomous and efficient organizations. This point will be further elaborated in section 2.4.

Management through core professional and support staff should be the next priority of the MCF. The Chief Executive Officer (CEO) should be a dynamic leader, demonstrate good management capabilities and be able to formulate good strategic plans for the organization. The CEO should be selected by the General Body/Governing Body through an open and competitive process. As far as possible, nomination by the government should be avoided. The CEO should have experience in government, civil society, and the private sector. The CEO should be free of traditional bureaucratic attitudes. The organization should have a dynamic and flexible operational procedure and good management information systems (MIS). Hierarchy in decision-making should be avoided. A collective decision-making process should be adopted, as far as is practical, so that decisions are owned by all staff which will help ensure the MCF’s smooth implementation.

The critical aspect of the institutional structure of the MCF is its independence and freedom from political intrusion. One of the strengths of PKSF in Bangladesh is that under the guidance of the highly respected General Body and Governing Body, PKSF has been able to operate without political interference. The extent to which organizations are able to operate independently partly reflects the commitment of the government. In some cases, however, it may be extremely difficult to avoid political interference completely. Nevertheless, political influence may be minimized with techniques which include spelling out the objectives and policies as simply and clearly as possible, making the Governing Body members directly responsible for achieving the objectives, limiting the number of public sector representatives on the board, appointing the Chairman, CEO and Board members for fixed terms, and enabling various private and non government bodies to directly appoint representatives to the Board.

Section 3. Funding

(i)   Seed money from the government should be the first source of funds. In fact, when the government initiates such a fund, as in the case of PKSF, international financial institutions and donor agencies are more likely to follow with matching funds in the form of loans or grants. The national government may provide seed money in the form of a grant to the MCF as a revolving fund or may provide it as a loan at a concessional rate (1-2%) for a long term period (minimum 10 years).

(ii)   International Finance Institutions (IFIs) such as the World Bank, IMF, IFAD, and ADB, which usually work through governments, can provide funds to MCFs established under government initiative. Alternatively, IFIs may provide funds to other privately established MCFs with a government guarantee.

Donor agencies (both multilateral and bi-lateral) can provide funds more efficiently to national MCFs than by channeling their funds directly to MCPs.

(iii)   National MCFs can also borrow on commercial terms from the International Finance Corporation (IFC) and other international private capital sources. Borrowing can be done from the Central Bank and other commercial banks within the country. Commercial borrowing by the MCFs should be considered at a more advanced phase of operation and not at the initial phase because the high cost of commercial borrowing will put additional pressure on the sustainability of the funds.

(i)   Sub-Regional MCFs can start with initial grants from the member countries.

(ii)   Donor agencies can provide grant money for a sub-regional MCF for loan programs as well as capacity building programs.

(iii)   CGAP, FWWB and other international microcredit networking organizations may also provide some funds. The host country and the host institution (APDC, CIRDAP, CIRDAFRICA) may also be requested to provide start-up and regular funds for the MCF.

At an advanced stage of operation, national MCFs can provide a bridge between the private capital market and domestic MCIs by rating the credit worthiness of MCIs and securitizing their portfolios. National MCFs may consider raising funds from the domestic private capital market by issuing special types of bonds (such as a social bond) which may be subscribed to by companies, banks and private individuals.

One of the most important challenges of the MCF is to select partner MCIs. Sometimes it is difficult to find an adequate number of efficient MCIs running MCPs at the grassroots level. As we have mentioned earlier, besides providing funds for MCIs, the other important objective is building sustainable MCIs. The MCF should not stifle innovation and should not impose any particular model. The experience of PKSF shows that its partner organizations are diverse in nature.

The MCF’s credit programs should have innovative, transparent and standardized procedures for MCI selection, loan processing, monitoring and supervision at the field level. One of the strengths of PKSF has been regular contact and consultation with partner MCIs and adoption of the approach of learning-by-doing. One must remember that standardization of procedures should not exclude flexibility and the need to adapt to varied conditions and new challenges coming from the field as well as from the MCIs.

As the experience of PKSF, with its diverse partner organizations shows, the MCF will not stifle innovation and will not result in the imposition of any particular model.

The MCF is expected to implement three interlinked programs :

(i)   A loan fund to partner MCIs for on-lending to the poor and poorest families. MCFs should not be engaged in direct lending to the poor.

(ii)   An Institutional Development (ID) Program for the MCF and Partner MCIs. This will consist of, among other things, training of MCF/MCI staff, developing management information systems (MIS), and capacity-building programs for MCIs so that they become sustainable institutions.

(iii)   Research: This should include periodic monitoring and special focus studies. The emphasis on action-research is helpful in identifying the MCPs’ strengths and weaknesses in order to make them more robust and effective. The primary and secondary impacts of MCPs on the poor and poorest families should also be evaluated periodically to sharpen the focus of the program and meet the goal of the Microcredit Summit Campaign.

The credit programs of the MCF should be run through its partner MCIs for cost-effectiveness and better management at the field level. The loan programs undertaken by partner MCIs should have the following characteristics:

1. MCIs provide loans to the poor and poorest families selected on some pre-determined criteria such as land owned, total wealth, nature of the dwelling/house.

2. The borrowers are organized in small groups.

3. Groups are formed of like-minded people from the same economic strata, ensuring confidence and trust in each other.

4. MCIs collect service charges (interest) from their beneficiaries depending on the field situation of the MCIs and their target clients. The administrative and related expenses of MCIs are met from these service charges.

5. The repayment period for the poor, landless/assetless people (i.e., beneficiaries) to the MCIs should be based on the nature of the income generating activity in which they are involved. However, it is preferable to keep it within a 1-year period (with some grace period).

6. The rate charged by the MCF to the MCIs should be set at a minimum level, allowing a greater spread between the MCF rate and the rate charged by the MCI to the ultimate borrowers.

7. Loans received by MCIs from the MCF may be for a period of 1 to 5 years. If the funds are given for 2 to 5 years the MCIs can revolve the funds at the field level by providing loans to different groups for a one-year period.

A set of selection criteria for MCIs to be funded has to be formulated so that the MCIs can be screened on the basis of the criteria. The criteria can be divided into the following broad areas: (1) Nature and mandate of the organization; (2) Governance and management structure; (3) Quality and experience of the senior management staff; (4) Human resources; (5) Geographic coverage; (6) Field activities including the profile of the poor and poorest clients; (7) Demonstrated performance; (8) Management Information Systems (9) Account and audit systems; (10) Portfolio and debt-equity ratio.

It must be pointed out that all the criteria may not have the same importance. The criteria will also vary depending on the number of borrowers of the potential MCIs and the funds required by them.

The MCF should not provide startup capital for MCIs and may stipulate a minimum period of 1 year of satisfactory operations.

One of the key pre-conditions for the success of a collateral-free microcredit program (MCP) is a sound accounting and auditing system. Therefore, the following steps should be taken by the MCF:

(i)   Prepare detailed and separate sets of accounts manuals, one for the MCF and the other for the MCIs.

(ii)   Prepare terms of reference (TOR) for the internal control and audit system of the MCF.

(iii)   Prepare TOR for audits of the MCF to be carried out by external and independent auditors.

(iv)   Prepare separate TOR for audits of MCIs to be carried out by the MCF and by external and independent auditors.

(v)   Prepare guidelines for the internal control system to be followed by MCIs.

The ultimate beneficiaries of microcredit are encouraged to save regularly - an integral part of group formation and group activities of MCPs. The MCIs under which the beneficiaries are organized usually manage and keep accounts of these savings. Every member of a group saves regularly (for example weekly) according to his or her ability. The savings collected are recorded in the passbooks of each borrower. Though each borrower is a net-debtor (in the sense that borrowing is greater than the accrued savings), mobilization of savings by MCIs is a sensitive issue because it is a financial service which can only be undertaken with specific permission from a government or central bank. Recently, savings (both regular and voluntary) have been quite substantial for many MCIs, and therefore prudent norms and regulations should be introduced to ensure the safety of savers. The MCF can raise the issue with the government to create an enabling environment for MCIs in savings collection by providing the MCIs with licenses and giving a legal identity for such activities. The MCF can formulate policy guidelines in six important areas: (i) collection; (ii) maintenance of accounts; (iii) withdrawal by depositors; (iv) investment of savings by MCIs (v) using some portion as a credit fund for borrowers; and (vi) rate of return on savings paid to the depositors by MCIs.

Full implementation of the policies and guidelines and the creation of new policies to manage default should constitute a major thrust of the program of the MCF. Default may originate from six sources: (i) misappropriation of funds or any major governance problem of MCIs; (ii) weakness in the MCI appraisal system, resulting in the selection of inappropriate MCIs incapable of managing microcredit; (iii) weakness in the management of microcredit by once-successful MCIs; (iv) natural disasters; (v) serious political disturbances; and (vi) severe economic downturns. The dominant position of the MCF with respect to averting default should be preventive in nature so that this kind of crisis does not occur. This is to ensure good governance of the MCIs through strong monitoring, supervision, policies and guidelines for good governance. The internal control system instituted among the MCIs should be strengthened and the efficiency of microcredit management should be enhanced through training and other institutional development programs.

To prevent default, the MCF must prepare an early warning system based on critical indicators of the MCIs’ performance. The system should be implemented to detect and avert any potential default.

There are dramatic differences among MCIs in terms of their credit operations and quality of service delivery. Therefore, there is a need to develop performance evaluation criteria to categorize various MCIs. The reasons are (a) to help the MCIs emerge as viable credit delivery organizations; (b) to help the MCIs gain institutional strength; and (c) to help them expand their credit operations systematically.

The MCF can have performance indicators for MCIs using the following broad categories:

1.  Viability of the microcredit borrowers, including: dropout rate, percentage of loans outstanding, savings rate, functional literacy, member/ borrower ratio, etc.

2.  Institutional viability, including avoidance of overlapping with other MCIs, (where there are numerous MCIs), accessibility of borrowers, marketing prospects, banking service, governance, and equity base.

3.  Program implementation, including: group members as a percentage of total target population, group cohesiveness, borrower attendance at weekly meetings, loan disbursement and recovery rate, skill of field workers, accounting system of the POs, and capacity of the top management.

4.  Human resource development program, including: recruitment, performance appraisal of personnel, and training.

5.  Periodic study of the impact of microcredit on poverty alleviation.

6.  Creation and maintenance of expected institutional culture, including: sound governance and incentive base for management and staff.

7.  Financial management and internal control, including: MIS, accounting system, internal audit, internal supervision and budgetary practice.

8.  Status of physical assets, including: ownership of building, land, furniture, vehicles.

9.  Financial and economic viability, including: operational, financial and economic self-reliance, and quality of portfolio.

Program implementation using standard procedures is a vital element for successful MCFs. The major elements of implementation are (1) Procedures for application for funding by MCIs; (2) Preliminary appraisal of MCIs; (3) Field visits to assess the field operations of MCIs; (4) Recommendations by the management of the MCF to select MCIs; (5) Approval by the MCF’s governing body; (6) Signing of a loan agreement; (7) Verification of loan utilization; (8) Application for successive loans to MCIs; and (9) Monitoring.

Monitoring of the credit program is crucial for its success. MCIs should monitor their MCPs at the field level, while MCFs have to monitor the MCIs’ programs in order to reduce their risk. For the MCFs to be successful, it is important to establish and enforce appropriate performance and reporting standards for the MCIs that they fund. A sound MIS based on regular reports from the field to MCIs and from MCIs to MCFs is vital. A computerized system at MCF and MCI head office levels will greatly enhance the management capabilities of these organizations. Insufficient attention to MIS by MCFs may represent a missed opportunity to improve the outreach and sustainability of MCIs and MCPs, which are important goals of the Microcredit Summit Campaign.

In most countries the endowment of human capital for MCPs is very limited. However, this limitation can be overcome by a comprehensive human resource development (HRD) package implemented jointly by MCFs and MCIs. Training of MCF and MCI staff is an important aspect. Proper training needs assessment (TNA) should be done for both MCFs and MCIs and pragmatic, operation-oriented training should be provided. PKSF, for example, has formulated 7 training modules for its staff and 12 modules for the staff of MCIs.

A good compensation package and incentive system has to be formulated for the MCFs and MCIs to recruit and retain talented, efficient and committed people in the MCPs. Finally, a HRD program committed to building and maintaining the right kind of institutional culture and ensuring effective management succession has to be developed for the sustainability of the MCFs and MCIs.

Section 6. Institutional Development

The institutional development components for both the MCFs and MCIs should be determined in line with attaining sustainability of each microfinance program as a whole. Three interrelated sustainability issues in microfinance must be properly addressed. These are:

(a) Sustainability of clients of MCIs; (b) MCFs’/MCIs’ financial & economic viability; and (c) MCFs’/MCIs’ institutional viability.

For the purpose of setting the general direction of activities undertaken by the MCFs/MCIs, sustainability of the clients must be monitored on a regular basis by using appropriate indicators (both process and impact indicators). For the MCF, monitoring the sustainability of both the MCIs and their clients will be required.

Using four sets of indicators related to (i) outreach, (ii) operating efficiency, (iii) portfolio quality and (iv) profitability, the sustainability mentioned in (b) and (c) can be assessed. PKSF and CGAP have done some work in this area.

Section 7. Regulatory Framework

This issue has come to the forefront because MCIs are providing financial services and products to the poor, outside the formal banking system.

In view of the history of MCIs (most of which are NGOs or self help groups), it can be argued that the conventional regulatory framework such as that of formal banks and financial institutions is not appropriate and hence not required under the circumstances prevailing in many countries. This is particularly in view of the fact that MFIs are not accepting deposits with checking facilities. The unique features of MCIs in the field of social and financial services with the core objective of poverty alleviation differentiate the industry from the formal financial sector and further justify this proposition. However, that does not in any way downplay the importance of having some strategic monitoring measures that are compatible and appropriate to MCIs’ objectives, institutional operation and development culture. The measures should incorporate user-friendly prudential norms/indicative guidelines in the form of a concrete ‘Code of Norms/Conduct’ which would ensure sound and organized growth of MCIs on a sustainable basis.

A set of financial standards, reporting formats and performance standards may be an effective way to keep the MCIs on the right track. There is a broad range of experiences to draw from in establishing appropriate standards, including the work being done by PKSF. Recent attempts to establish such MCFs in other countries are a move in the right direction, because, among other functions, MCFs will be an effective institutional option to fund startup MCPs within a poor/poorest-friendly regulatory framework. An independent autonomous apex body outside the government’s control may be formed to ensure that the 'code of conduct' and the microcredit standards are complied with by the MCIs. Non-compliance by the MCIs may ultimately result in cancelling the permission/registration of a defaulting MCI. This apex regulatory body for MCIs has to work very closely with the MCFs.

Section 8. Interface Among Sub-regional MCFs, National MCFs and National MCIs

A broad framework of interface between these three types of institutions should be kept in mind in a “dynamic and process” dimension because such an interface cannot be imposed once-and-for-all; but it will evolve. However, the following guidelines may be considered:

(i)   In a country where there is huge potential for MCPs and an emergence of MCIs, a national MCF should be the apex funding agency for MCIs of that country.

(ii)   In a country where MCPs and MCIs have limited scope, that country can link with similar countries and form a sub-regional MCF, which will be the apex funding agency for the MCIs of the member countries.

(iii)   The two types of MCFs outlined above (i and ii) may form a network to exchange information and ideas and through that network, the MCIs of various countries may exchange information and ideas.

Section 9. Concluding Remarks

Many 'experts' have argued that wholesaler organizations (apex organizations) have failed in different countries. PKSF, however, is cited as an exception. While we agree that there are some unique features, we also argue that the preconditions for creating a successful MCF like PKSF can be fulfilled by many countries. None of the apex organizations studied by the experts, except PKSF, was designed from the beginning as an apex organization focused on promoting microfinance. All of the other organizations studied began with a donor-induced program and then through a perverse process of changing roles induced by donors, they started operating as apexes for MFIs. This process evaporates the institutional sense of ownership. This may be one of the fundamental reasons these institutions have failed.

PKSF’s experience shows that an apex organization’s costs for supplying resources to MFIs, with the ultimate objectives of reaching the poor with credit and enhancing the capacity of MFIs, can be done cost-effectively compared to other donor-induced arrangements. PKSF has supplied Tk. 7.94 billion (US $147.4 million) as a revolving fund to its partner MFIs (POs) over the last 10 years. This has enabled the POs to disburse Tk. 28.13 billion (US $522.4 million) as microcredit. The cost of supplying resources to POs was 5.47% during this period.

The expenditures of PKSF for the training and capacity enhancement of its POs was only 6.94% of PKSF’s total expenditures. It should be noted that expenditures for training and capacity enhancement are an integral component of the total expenditures made for supplying funds to POs.

The creation of a domestic apex should not be expensive if the government is convinced of the

importance of promoting microfinance. In Bangladesh, microfinance could not have reached its present stage without the long-term public policy adopted by the government. The microfinance sector of Bangladesh has received continuous support from the government. For example, the government recently provided a tax exemption on the corporate profits of PKSF so that PKSF can increase its equity quickly. Recently, institutions similar to PKSF have been set up in Pakistan (Pakistan Poverty Alleviation Foundation) and in Nepal (Rural Microfinance Development Centre Ltd.). Both of these new institutions have not started with a very well-developed NGO-MFI sector. In fact, RMDC started funding only 7 partner organizations and PPAF not more than a dozen. Therefore, attacks by the skeptics of autonomous funds are challenged by the realities in the field. The apex funds are proving their enormous potential to reach the forgotten poorest people on earth.

Section 10. PALLI KARMA-SAHAYAK FOUNDATION (PKSF) : THE APEX NATIONAL MICROCREDIT FUND IN BANGLADESH (Case Study)

PKSF was set up in 1990 by the government of Bangladesh with the overall objective of alleviating poverty and improving the quality of life of the rural poor, the landless and the assetless people by providing them with resources for the creation of self-employment to enhance their economic conditions. The specific objectives of PKSF are:

a) to provide various types of financial assistance to non-government, semi-government, and government organizations, voluntary agencies and groups, societies and local government bodies, so that as Partner Organizations (POs) and consistent with the Foundation’s image and objectives, they can undertake activities with the goal of generating income and employment opportunities among the most economically disadvantaged groups in the society;

b) to assist in strengthening the institutional infrastructure of the POs, so that they can improve their present operations.

 

The basic operational strategies of the Foundation have been drawn from its objectives:

a) It does not directly lend money to the landless and the assetless people in the rural areas: rather it reaches its target groups through Partner Organizations - the delivery mechanism for reaching the poor.

b) It provides greater thrust to institutional development.

c) It favors no particular model, instead it encourages innovations and different approaches based on experience.

Legally PKSF is a “company limited by guarantee” meaning “company not for profit” and is registered under the Companies Act of 1913 with the Registrar of Joint Stock Companies. The legal structure of PKSF gives it the flexibility, authority and power to take programs and implement them throughout the country. PKSF can receive grants and loans from local and/or international sources. It can also lend and approve grants.

a. General Body: The maximum number of the members in the General Body is 25, out of which the government may nominate not more than 15 members associated with government agencies, voluntary organizations or private individuals. The remaining 10 members are chosen from persons representing the Partner Organizations and/or private individuals. The General Body usually meets once a year for overall policy guidance. Presently, PKSF has a General Body of 15 members who are distinguished personalities in the country.

b. Governing Body: The composition of the Governing Body is as follows: (i) Chairman of the Foundation (nominated by the Government); (ii) Managing Director (appointed by the Governing Body); (iii) Two members nominated by the Government; and (iv) Three members elected by the General Body - a total of a 7-member Governing Body. The present Governing Body is comprised of persons of international repute, including Professor Mohammad Yunus, Managing Director of Grameen Bank.

c. Chairman: The Chairman of PKSF is nominated by the government from persons not in service to the republic. The Chairman usually serves for a term of three years. The present Chairman is a leading economist and a Professor of Dhaka University.

d. Managing Director: The Managing Director is the Chief Executive Officer (CEO) of the Foundation. He is an ex-officio member of the Governing Body.

e. Management: PKSF has three broad divisions: (i) Loan Operation (divided into two parts: one for large POs and another for medium and small POs); (ii) Administration & Finance; and (iii) Audit: The Audit division reports directly to the Managing Director.

PKSF has research and training units which conduct research related to poverty alleviation and provide training to the staff of the Partner Organizations.

PKSF implements three complementary programs:

(a) A loan program for the rural landless and the assetless people through Partner Organizations;

(b) An institutional Development Program for the POs; and

(c) Research

The loan program is the core program. The institutional development program is a support program to strengthen the POs into sustainable delivery systems for the poor. It trains PKSF and PO staff; develops Management Information Systems (MIS); and provides interest-free loans to POs for buying computers, motorcycles, etc.

a. Application in prescribed form: PKSF receives applications for loans in a prescribed application form that requires the applicant to include details about the organization, program, financing, etc.

b. Preliminary appraisal: If an organization has experience managing a credit program for the poor, PKSF will do a field visit. PKSF judges experience in managing a credit program using several criteria: (a) number of years of experience; (b) amount of loans disbursed; (c) number of members and borrowers; (d) loan recovery rate; (e) adequacy of skilled salaried staff; and (f) credibility of the sponsors.

c. Field visit: Once an organization is selected for a field visit, an officer visits the organization. If the performance of the applicant is found to be satisfactory it is recommended for acceptance as a PO. If there is some deficiency, the organization is kept under observation and suggestions are given for improving the performance. However, if the performance of an organization is found to be unsatisfactory, the application is rejected. The main reasons for rejection are, usually, financial mismanagement or gross inconsistency between information in the application and that gathered from the field visit.

d. Approval by the Governing Body: The final decision on accepting a PO rests with the Governing Body. If the management considers an organization qualified to be a PO, the proposal is forwarded to the Governing Body along with a detailed description of the organization, the field report, rationale for accepting it as a PO, and recommendation of the managing director. The Governing Body accepts, rejects, or puts conditions on acceptance of the organization as a PO.

e. Signing of Loan Agreement: The final step in disbursing a loan to the newly selected Partner Organization is the signing of a standard loan agreement. The loan agreement contains terms and conditions of the loan (e.g., rate of service charge, area of loan disbursement, number of installments). The loan is collateral-free. In addition to a loan agreement, a promissory note is signed by a representative of the PO. The loan agreement is signed for PKSF by the Managing Director and for the PO by the Chief Executive of the PO or sometimes jointly by the Chief Executive and the Chairman.

f. Verification of Loan Utilization: After the first loan is given, the PO is supposed to disburse the funds immediately and provide a list of borrowers to PKSF. An officer from PKSF in charge of the PO visits to verify the loan disbursement and utilization of the loan by the members. PKSF officials usually visit the POs every three months.

g. Application for Successive Loans: The approval of successive loans depends on several factors: (a) satisfactory utilization of the previous loan; (b) maintaining a high rate of loan recovery at the field level (>98%); (c) submission of regular reports to PKSF; (d) potential for expansion of the loan program; and (e) repayment of loan installments to PKSF, if due. Successive loan proposals of up to Taka 2.5 million (US $46,425) are approved by the Loan Committee. The Loan Committee is headed by the Managing Director of PKSF. Other members are the senior management of PKSF. This Committee has been set up by the Board of Governors to delegate some authority and decentralize power. A similar loan agreement is signed for each installment of a loan. Loans above the Tk. 2.5 million (US $46,425) limit are approved by the Governing Body.

h. Monitoring: Monitoring of the credit program is crucial to its success. POs monitor their programs at the field level and PKSF monitors the programs both at the field and office levels. Since PKSF provides collateral-free loans to POs, the only way to reduce the risk is to monitor the programs regularly. Several complementary steps are taken to monitor the activities of POs, especially the credit program and fund management. A brief account of the monitoring system is given below:

(a) Collection of program information: As previously mentioned, PKSF uses a standard form every month to collect information on changes in borrowers, savings, loan disbursement and recovery.

(b) Financial position: POs submit cumulative and monthly income, expenditure and cash flow statements to monitor the financial health of the PO.

(c) POs regularly send their lists of borrowers to PKSF. These are borrowers from fresh installments of loans from PKSF or loans from the revolving fund.

(d) Field visits: Field visits by the officers of PKSF are the backbone of monitoring the POs. PKSF places the utmost emphasis on field visits. Usually, the officer visits each PO every three months. However, if the PO is big and has multiple branches, a team of PKSF officials visit the program. During the visits the information submitted by POs as mentioned in (a), (b) and (c) is verified. Suggestions are made for improvement. The field visit is used for verification of the program and for institutional development of the PO.

(e) Audit by internal audit team: PKSF conducts an annual audit of all its POs. The audit reports are submitted to the CEO of PKSF directly.

(f) Audit by audit firm: As a part of the annual financial auditing of PKSF, an external audit firm verifies the financial position of sample POs.

10.7 Fund : Total funds received and committed from different sources are as follows:

(i) Grant from government = US$ 21.6 million

“ “ World Bank = US$ 5.0 million

“ “ USAID = US$ 12.7 million

(ii) Loan from government = US$ 10.0 million

“ “ World Bank = US$100.0 million

“ “ ADB = US$ 18.0 million

“ “ Others = US$ 0.6 million

Total = US$ 167.9 million

a. Enlistment of POs: PKSF has accepted POs every year since its inception. Starting with 23 POs in its first year of operation, PKSF has enlisted 189 POs as of December 2000. The POs of PKSF work in 62 out of Bangladesh’s 64 districts.

b. Loan disbursement: PKSF has disbursed Taka 7,049 million (US$140 million). With the revolving nature of the fund and with additional funds, the POs have extended about Taka 21,000 million (US$411 million) at the field level.

c. Loans outstanding: PKSF has Taka 5,244 million (US$103 million) in loans outstanding with POs as of December 1999.

d. Borrowers: As of December 1999, the total number of borrowers financed by PKSF was 1.87 million, more than 90% of whom were women.

e. Recovery of loans: PKSF has two different recovery rates: (a) recovery rate of loans between the PO and PKSF; and (b) recovery rate of POs. PKSF’s recovery rate over the last 6 years has been nearly 98%. This rate is defined as the percentage of the amount due received on time. Loan recovery of POs at the field level is 99%.

f. Strengthening of the POs: One of PKSF’s main achievements is the development of local institutions. Most of these NGOs run their programs with loans only from PKSF. Still, they are successfully able to cover almost the full amount of their cost of operations, and many have approached financial viability. Aside from financial viability, local POs are now better prepared to manage their programs because of the training, advisory services and institutional development program of PKSF. These include training, development of accounting systems and MIS, and continuous management suggestions for improving their programs.

g. Potential for expansion: The total number of borrowers of PKSF's POs is over 2.1 million (including that of BRAC, ASA & Proshika). There is scope for further expansion of loans to the POs. In addition, PKSF is accepting new POs every year and existing POs are also expanding their coverage.

h. Training and advisory services: PKSF arranged several workshops for the directors of POs. These workshops mainly discussed policy issues in order to introduce uniform systems to the POs. Sessions were arranged to provide training in accounting and MIS for the accountants and credit coordinators. PKSF has prepared 19 modules for training its staff and different levels of the POs’ staff. One effective way of training staff is through practical training sessions given by the officers of PKSF during their routine visits to each PO. During these visits problems are identified and solutions are provided. Regular discussions are held with the organizers and field staff during the field visits.

i. Research programs: So far, PKSF has conducted two research studies on the impact of its program on the beneficiaries. There have been several studies on PKSF by various authors in Bangladesh and abroad. Recently, PKSF has commissioned a multi-year impact study to the Bangladesh Institute of Development Studies (BIDS), the premier research institution in Bangladesh.

j. Impact: Various research studies have shown the positive impact of microcredit on the lives of the rural poor in Bangladesh. A set of indicators has been suggested to study the impact further.

a. Institutional sustainability of POs: Fundamental policies to run a successful rural credit program are in place in many POs. Selection of members, savings and loan policies, portfolio management, financial control, and monitoring and evaluation are the fundamental areas of policy formulation.

So far, many POs within their limited capacity have tried to recruit competent staff. POs do not have adequate financial resources to recruit staff with better educational attainment and competence. Many POs are being managed by their founders and are expected to do so for quite some time. Leadership by the present directors at this early stage of the organization is important for growth and sustainability. Many POs either have physical assets like office buildings and land or have purchased land for construction of an office, a training center, etc. This shows a clear commitment on the part of the organizers to giving the POs a solid foundation.

Financial sustainability of POs: The basic issue in financial viability analysis is whether POs can cover the costs of managing their credit programs from the income of the programs, mainly the service charge from loans. Some POs have been successful by gradually covering the cost of operations from the income of the credit program and generating a moderate surplus. It is expected that all POs will continue to improve their profitability.

Role of PKSF: Directors of POs have identified several areas where PKSF has made significant contributions: (i) by providing funds, PKSF helped ensure the expansion of programs and enabled them to become financially viable, (ii) PKSF assisted in developing the credit management, MIS and accounting systems, (iii) PKSF's regular advisory services helped gradually improve the capacity of POs in managing their programs.

Future role of PKSF: The future expected role of PKSF has also been identified by the Directors of PKSF which are: (i) the continuation of providing loan funds should be the main role of PKSF, (ii) PKSF should help train all of the POs' staff for further improvement of their capacity, which will be their basis for sustainability, (iii) continuous advisory service, and (iv) PKSF should conduct research not only in microcredit but also in other related areas of poverty alleviation (PKSF has recently decided to provide funds on a pilot basis to microenterprises, to the urban poor and to the poorest of the poor).

Institutional sustainability of PKSF: PKSF has a competent and dynamic Governing Body capable of guiding the management, changing policies and introducing programs as necessary. It has well-established transparent policies regarding the loan program as well as management of its affairs. It has gradually increased its outreach by enlisting an increasing number of POs. PKSF has been able to mobilize the financial resources required to embark on a large-scale expansion of its activities. These factors will continue to contribute towards the expanded operations of PKSF.

Financial Viability: PKSF has been able to gradually improve its financial position. It has been successful in increasingly covering the cost of its operations by charging a reasonable service charge, increasing loan disbursement, keeping both its operating expenses low and the loan loss expenses very low by maintaining a high recovery rate. Overall, PKSF has posted a surplus every year since its inception. Some of the financial data of PKSF as of 30 June 1999 is as follows:

(i)   Debt-equity Ratio 1.63:1

(ii)   Cumulative Loan Recovery Rate 98.16%

(iii)   Reserve Rate (Loan loss reserve/loan outstanding) 2.67%

(iv)   Operational expenses to loans disbursed (operational expenses/disbursement of the same year) 5.28%

(v)   Operational self-sufficiency (Total income/operation expenses including financial expenses + DMR) 161%

(iv)   Percentage of total expenditure to total income 36.43%

Financial ratio analysis shows that PKSF is in a sound position. The debt-equity ratio, the portfolio and self-sufficiency ratios show that the performance of PKSF is good in terms of operational and financial self-sufficiency. The cost structure and the profitability analysis also show that PKSF is covering all the expenditures from its loan operations income and also generating a profit.

PKSF is unique in its organizational structure, activities and management practices. Here are a few factors that have made it possible to register such an impressive performance, as follows:

PKSF has been established and funded by the government, but it has been kept as an independent organization outside the government bureaucracy. That enabled PKSF to form its own policies and develop its own management practices suitable for its activities.

The outstanding quality of the Governing Body has contributed most in guiding the management and forming and revising policies whenever necessary.

The policy of recruiting officials of above average quality has contributed greatly to the growth and performance of PKSF.

PKSF has been successful in utilizing the capacities of local NGOs in quickly reaching the poor and developing the POs to deliver the financial services to the poor. Selection of the right POs was the most crucial factor for PKSF’s success.

The key to the sustainability of POs is the assured source of funds and the improvement in the capacity of human resources backed by good management practices. In both areas, PKSF has proved to be effective.

Financial intermediaries (NGOs) backed by resources from PKSF have been found to be effective in reaching the poor. Both PKSF and the POs can also become sustainable in the process.

The rural poor and poorest men and women have proven themselves to be capable of managing money and improving their income. Likewise, the POs of PKSF have proven the ability to select the right target groups and deliver the desired services.

One area that needs top priority from PKSF is enhancing the capacity of POs. This can be done by more investment in development of the POs’ human resources.

The PKSF model (as an apex second-tier organization) shows potential for replication. It can further grow and make a significant contribution in improving the quality of life for the poor and poorest.

Section 11. FONCAP S.A.-FONDO DE CAPITAL SOCIAL ARGENTINA (Case Study)

The "Fondo Fiduciario de Capital Social" (FONCAP) is an innovative initiative of the government of Argentina, created at the end of 1997.

A)   There was a need for a microcredit fund in Argentina because institutions did not exist with the necessary capability, economic strength, and commitment to serve the poor and the poorest.

B)   The purpose of the fund is to fight poverty and unemployment. FONCAP's aim is to create a self-sustaining and self-perpetuating scheme that will provide financial and non-financial services to poor microentrepreneurs across the country, operating as a second-tier institution.

FONCAP is the response to an unavoidable reality: the existence of almost two million microentrepreneurs in Argentina, striving to survive amidst one of the toughest economic transformations of the country's recent history.

FONCAP has been designed with the intention of coordinating the strengths of three sectors - social, private and public - in order to develop an organization which aims at maximizing the contributions that each party can make in terms of their capacity to serve the poor, and at the same time neutralizing their particular weaknesses.

FONCAP's mission is to eliminate the barriers to access to credit for the poor, safeguard their interests and link them with the other sectors of society.

C)   FONCAP’s objectives match the Microcredit Summit’s goals in almost all of its work, including: reaching the poorest families, empowering their female members and building financially self-sufficient institutions. With regard to the impact on the lives of clients and their families, FONCAP is developing tools in order to measure as accurately as possible the results of the practitioners’ operations in terms of social welfare and improvement of quality of life.

D)   Strategies of credit program: FONCAP intends to promote the Argentine micro-finance sector through the creation, strengthening and expansion of local microbanks. It also aims to create the infrastructure necessary to scale-up financial services to microentrepreneurs and to create a promising network of practitioners.

The most important thing for FONCAP’s future, after building a new governance structure, is to strengthen its capacity of reaching the poor with financial services through sustainable partner organizations similar to the approach successfully taken up by PKSF in Bangladesh.

A) Legal/Ownership Structure: FONCAP’s microcredit fund amounts to US$40 million which is at present entirely funded by the Argentine government. Through a 30 year fiduciary agreement, the fund is managed by FONCAP SA, a private corporation whose stockholders are the government (with 49% of the shares), and private NGOs (with the remaining 51%). This scheme, with the majority interest in private hands, ensures the autonomy of the fund and allows it to set long-range policies and strategies regardless of changes in public administration.

B) Governance Structure: The governing body of Foncap is the Board of Directors. Its composition reflects the primacy of the private sector, which is represented by 9 members, while the government is represented by only 4. To ensure effectiveness and autonomy, only the Board is empowered to hire and dismiss the managers and mid-ranking managers.

C) Management: The microbank and microenterprise area managers constitute the core staff of the organization.

In the microbank area, the core portion is the microbank financial services sector, which has the following assignments:

• Evaluate the financial viability of microbank projects, submit business plans to the Board for their approval, and administer the disbursement of loans and grants according to the correct allocation of these resources by each microbank. Then, supervise and control these operations in order to identify any deviations either in terms of outreach and expansion of the operation or the population being served.

• Prepare monthly reports on the progress of each microbank, the quality of the service provided, and the population being served, with respect to the goals established in each business plan.

• To lead in the development and utilization of other financial instruments suitable to meet the special circumstances of certain practitioners which provide services to urban and rural microenterprises.

The support staff - Microbank Strategic and Technical Assistance - has the following responsibilities:

• Transfer and adapt the practitioners' microcredit technologies and methodologies which have proven to be effective and efficient, for use by other practitioners.

• Introduce and educate potential practitioners in microfinance best practices.

• Encourage participants representing the corporate and financial markets to support, create and develop microbank operations.

• Facilitate generation of an increasing supply of human resources specialized in microfinance.

• Promote the specialization of microfinance support services in fields such as market consulting, human resources, computer systems, and training.

11.3 Funding: how to forge partnerships and obtain funds while ensuring autonomy

FONCAP's bylaws allow the creation of new microcredit funds and new trustees. The initial US$40 million in stock is considered seed money, available to match investments with other donors for the development of new funds to assist poor microentrepreneurs. These funds can be focused on regional (e.g., a microlending operation in a province) or sectorial criteria (e.g., poor women in the agricultural sector). The goal is to identify these regional and sectorial needs and set partnerships with corporations and NGOs with specific and local interests in developing these initiatives. The replication of FONCAP's model across the country will encourage the decentralization process, ensuring more and more autonomy.

At this time FONCAP does not consider it necessary to require institutional or commercial borrowing. Funding has not been a constraint so far. The real bottleneck is the capacity of microcredit programs to deliver services to the poor and poorest.

a) Eligibility criteria of MFIs to be funded:

The MFls who either directly or indirectly use resources of FONCAP shall meet the following requirements:

• Be part of the private or social sectors, showing an express commitment to the provision of services to microentrepreneurs;

• Demonstrate an exclusive dedication to the provision of services to the microenterprise sector (by the institution, or by a program of the institution with separate and auditable accounting independent from other activities);

• Have a core management team with exclusive dedication;

• Adopt criteria of action which favor effectiveness, efficiency and the self-maintenance of the institution or of the programs thereof;

• Submit a Three-Year Action Plan which demonstrates: reasonable levels of technical knowledge for corporate leadership and management; ability of the organization to fulfill its objective; adequate physical environment for performing its activities; adequate methodology for technical, economic, financial and institutional evaluation of entrepreneurs to be financed and trained;

• Hire an external auditing firm from among those approved by the Board of Directors, to audit their balance sheets and their business performance;

• Allow the National General Auditing Department or whomever the latter appoints within its budget estimates, acting as Auditor of FONCAP management, to audit its balance sheets and business performance.

b) Accounting, Auditing principles: As discussed, the MFIs agree to be audited and monitored by FONCAP's staff or outside contractors. Basically, FONCAP performs three types of control:

• Monitoring the development of the microcredit program according to the goals established in the Business Plan: this monthly exercise focuses on the evolution of number of clients, outstanding portfolio, operational income and expenses, and all relevant information essential to determine the degree to which the MFI has accomplished its goals of activity level and operational self-sufficiency.

• Auditing of portfolio quality: This exercise occurs four times a year and consists of checking the payment behavior of a representative sample of the outstanding clients of the MFIs. The results of this auditing process may lead to adjustments in an MFI's credit methodology and amount of provision for bad debts.

• Clients Auditing: This exercise occurs four times a year and consists of checking the profile of the clients the MFI has in its portfolio. In this way, FONCAP keeps control over whether funds are reaching the poor microentrepreneurs or are being used in an improper way.

c) Management of savings: FONCAP has a neutral role with regard to this item. The mission of the microcredit fund is to develop a countrywide lending capacity to serve the poor and poorest microentrepreneurs.

d) Default management and performance evaluation of MFIs: The information provided by the MFIs and the reports from the auditors and monitoring personnel set the basis for performance evaluation that includes:

• Channeling of funds to FONCAP's target population. If the MFI does not fund poor microentrepreneurs, its contract may be terminated.

• Portfolio quantity analysis: amount of outstanding portfolio and number of clients.

• Portfolio quality analysis: determination of the amount of bad debts and its impact on the MFI's net worth.

• Analysis of the ratio liabilities/net worth: it must not exceed seven.

• Analysis of the audited operational income statement to check if self-sufficiency has been attained or is possible to be attained in a reasonable period.

• FONCAP is developing measurement tools to evaluate the impact of microcredit on the poor and poorest.

a) Management Information Systems (MIS): The members of FONCAP's Board are able to access information on both FONCAP and the MFIs operations.

b) Human resource development: One of FONCAP’s main goals is to facilitate the generation of an increasing supply of human resources specialized in microfinance through training courses coupled with field work for practical and concrete experience.

c) Institutional Development: Through the support credit line, FONCAP has made available an annual amount of US $4 million for creating capacity and institutional and financial sustainability of MFIs and also has additional resources to strengthen its own capacity. This type of loan, convertible to grants, has been shown to be a powerful tool in order to reach financial sustainability and institutional strengthening MFIs, especially those who are new to the field.

d) Regulatory Framework: FONCAP has developed a project to prepare a regulatory framework for the microcredit sector. Two consultants are engaged in this work. FONCAP’s goal is to get a sanction from the government for a law setting a legal framework that will contribute to the consolidation of the microfinance industry. 

Section 12. LOCAL INITIATIVES DEPARTMENT IN BOSNIA-HERZEGOVINA (Case Study)

12.1 The Local Initiatives Departments (LIDs) were established in 1996 to administer the World Bank-sponsored Local Initiatives Project. The LIDs are departments of government-created Employment and Training Foundations (ETFs) established in each of the constituent Entities of Bosnia and Herzegovina - the Federation and the Republika Srpska. The ETFs channel donor funds to employment-related programs. The LIDs operate with a great deal of autonomy within the ETFs and the LIDs from each entity work in close cooperation and share certain functions and staff.

The LIDs operate as apex institutions. They channel donor funds to MFIs that provide credit to target clients. The LIDs monitor the performance of the MFIs and make financing decisions based on performance. The LIDs also provide technical assistance and training to their partner institutions to help strengthen their institutional capacity and knowledge of microfinance best practices. They also work to establish a more favorable legal and regulatory environment for the legal establishment of MFIs in Bosnia.

The establishment of the Local Initiatives Project was carried out in early 1997, after a pilot project implemented by six NGOs during 1996. After an intensive screening process, the LIDs selected seventeen NGOs as implementing partners, twelve in the Federation and five in Republika Srpska. Contracts were signed with these organizations in the Federation in April/May 1997 and in the Republika Srpska in September/October 1997. Out of the 17 NGOs, 14 are local and three are international.

MFIs are initially contracted as agents under a performance-based Agency Agreement. The LIDs provide loan capital to the MFIs to manage and on-lend to target clients. Financing for start-up capital investments and operating costs is also provided as a grant, on a declining basis. Technically, the LIDs own the loan funds, but the MFIs manage this lending capital as if it were their own. From the interest income earned, the MFIs cover losses, pay a fee to the LIDs for the use of their funds, and pay a growing portion of their operating expenses. This arrangement allows the LID to test out institutional capacity and recover the loan capital in case of poor performance and bad repayment. It also provides a legal basis for such on-lending in an environment where NGOs have no explicit legal authority to lend.

12.3 MFI Performance

In late 1998, the LIDs carried out a performance assessment of their 17 partner MFIs based on institutional and financial criteria. The purpose was to assess which organizations had demonstrated the capacity to become sustainable microfinance institutions. All institutions have performed well. The number of active clients per MFI ranged from 150 to 1,500 with average outstanding porfolio ranging from DM250,000 (US$125,000) to DM2.2 million (US$1.1 million). MFIs had developed varying capacity for loan analysis, loan tracking and portfolio reporting, delinquency management, financial management and internal controls. Key performance indicators were also good:

However, not all MFIs were able to meet the LIDs’ assessment criteria. Based on the assessment, the LIDs decided to continue financing five MFIs in the Federation and three MFIs in Republika Srpska.

Supporting the institutional capacity building of the partners is one of the LIDs' main goals. Technical assistance and training have taken the form of seminars, study tours and technical advice.

During 1997-98, eleven seminars were held on the following topics: Principles and Methodologies of Microcredit; Credit Officer Training; Accounting and Financial Management; and Planning for Sustainability. Three study tours were also organized to Bolivia, Egypt and Poland.

The 1999 Technical Assistance (TA) program was designed based on the inputs of the MFIs provided during a participatory planning workshop held in December 1998. The program aims to reflect the MFIs' requests that TA is:

• responsive and demand driven

• provides continuity and consistency

• tailored to individual organizations' needs.

The 1999 TA program has comprised seminars, study tours and individual consulting in the following areas: information dissemination on microfinance best practice to all MFIs in Bosnia and Herzegovina; accounting and financial management training; study tours to Bangladesh, Colombia and Poland; management training; board development training; and training on the new legal framework and institutional development.

A primary goal of the Local Initiatives Project is to create a clear legal and regulatory framework for the provision of credit and savings services for the self-employed and microentrepreneurs. In 1998, a participatory process was launched to develop such a framework with the support of the World Bank and USAID. Expert teams were established in each entity, comprising representatives from the microcredit practitioner community, the Ministry of Finance, the Banking Agency and the Local Initiatives Department.

By the end of 1998, a draft proposal had been developed establishing four legal forms:

• Microcredit association (credit only, non-profit organization, no formal supervision)

• Finance company (credit only, for-profit corporate entity, no formal supervision)

• Credit and savings association (membership-based credit and savings services, licensed and supervised by Banking Agency)

• Microfinance institution (credit and savings, corporate form, licensed and supervised by Banking Agency)

The draft proposal will be further discussed and presented to the government for consideration and legal enactment.

12.6 LIDs Portfolio Performance (December 31, 1998)

Total loans disbursed : 14,347

Total value disbursed : 41,373,660 DM (US$ 20,694,974)

Total no. of active clients : 8,864

Total portfolio outstanding : 149,467,435 DM (US$ 74,763,139)

The Local Initiatives Project has raised a total of US$ 19 million from the World Bank, UNDP, UNHCR and the governments of Australia, Italy, Japan, The Netherlands, Norway, and Switzerland. Over 70% of funds so far received have been used in the microcredit loan fund.

12.7 Future Perspective

The LIDs strategic goal is to support microfinance institutions that have demonstrated the capacity to reach financial sustainability and provide continued services to large numbers of low-income entrepreneurs.

All MFIs that meet mutually agreed upon performance standards will be eligible for capitalization by the LIDs as independent, financially viable microfinance institutions. These standards include:

• a clear vision and commitment to low-income entrepreneurs

• a viable strategic business plan

• an accounting system which meets international standards with internal controls

• first loan less than 5000 DM (US $2500) and average loan size of less than 10,000 DM (US $5,000)

• Less than 5% portfolio at risk after 30 days

• Less than 3% write off (of average outstanding portfolio annually)

• Less than 5% rescheduled loans within active portfolio

• Cover all costs from non-grant sources (i.e., income from operations) including loan loss reserve and the cost of funds adjusted for costs currently subsidized by donors

• 10% of assets funded by local resources other than retained earnings.

LID will learn more about the impact of these loans on the clients' businesses and their families’ income and well-being, as well as learn more about other constraints facing self-employment and microenterprise development. The LIDs will also continue to work on putting in place an appropriate legal and regulatory framework for MFIs.

The Role of An Apex Financial Institution to Finance Micro Credit Programs: The Palli Karma-Sahayak Foundation (PKSF) in Bangladesh by Dewan A.H. Alamgir, CDF/CGAP, Dhaka, 1997.

PKSF, Annual Report 1997-98.

The World Bank, Staff Appraisal Report: Bangladesh Poverty Alleviation Microfinance Project, August, 1996.

FONCAP S.A - Fondo de Capital Social; Various Reports.

LOCAL INITIATIVES PROJECT: Microenterprise Lending in Bosnia and Herzegovina; Report dated January 1999.

Yunus, Muhammad; "How Donor Funds could Better Reach and Support Grassroots Microcredit Programs Working Towards the Microcredit Summit's Goal and Core Themes". Abidjan, June 1999).

Notes

1.  The Microcredit Summit Campaign defines "poorest" as those in the bottom half of those below their nation's poverty line.

2.  For the purpose of this paper, the 1997 Microcredit Summit and the Summit's nine-year fulfillment campaign, any reference to microcredit should be understood to refer to programs that provide credit for self-employment and other financial and business services (including savings and technical assistance) to very poor persons.

3.  At the very outset, three terms: MCF, MCI and MCP should be clearly understood. MCF refers to an apex or second tier fund which operates as a wholesaler of microcredit; MCI refers to the institutions (NGOs, cooperatives etc.) who are engaged in retailing activities (on lending to actual borrowers); MCP refers to microcredit programs of MCIs. The distinction between MCIs and MCPs is that MCPs are program components of MCIs. In addition to MCPs, many MCIs undertake other programs (credit plus) such as health, education, nutrition, etc.