Compendium 2.3.3 Adapting financial products
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2.3.3 Adapting financial products
Although it cannot be said that the individual solutions being tested by EQUAL constitute global innovations in microfinance methodology, they do provide a series of lessons on how to integrate different aspects of microfinance and to adapt them to the real needs of specific target groups in quite different national and regional contexts.
EQUAL demonstrates how important it is to find out about the real (rather than assumed) financial and business needs of disadvantaged groups. A shift is required from simply selling a specific financial product to adjusting both products and services (based on solid experience of or research into the target groups) so that they genuinely help to increase income flows and the ability to repay a loan.
The products offered, and the procedures operated, by most financial institutions are often discouraging for non-traditional entrepreneurs. Talking of loans to microenterprises, the amount required may be too small to offer the prospect of reasonable profit for the lender. Borrowers may be unable to put up sufficient collateral. There is a growing consensus that interest rates are not the most important factor. Many microfinance institutions charge more than market rates in order to increase the sustainability of the funds. Some funds make a fixed service charge in order to avoid religious objections to the payment of interest.
The main focus within EQUAL has been on smaller sized loans and exploring the use of the various techniques for controlling risk (substitutes for collateral). Most loans (REGIO study , ADIE, Prince’s Trust, AWE) are around €5,000, with relatively few schemes with loans of over €15,000.
As concerns social enterprises, which are more “people-centred” than “money-centred”, the barriers are to do both with their assets and their aims. More specifically, difficulties may concern:
- the legal form of social enterprises, which limits the raising of equity, consequently leaving them in accounting terms with a very high gearing;
- the aims of the organisations that do not boil down to mere profit-making;
- the ownership structure of the organisations, which may be very decentralised and combine different forms of stakeholders whose effective influence may not be clear to outsiders;
- the management and decision-making structure which may be of democratic nature or based on complex consultation systems;
- the markets that these organisations serve which may be low-return sectors in financial terms;
- the income structure, which can be a fairly complex mix of public, private and market incomes, in addition to voluntary work and other in-kind contributions, whose nature and sustainability is not always easy to understand;
Beyond these difficulties related to what social enterprises are and do, there are recurring deficiencies both on the demand and on the supply side of finance. On the demand side, these are:
- deficiencies in the accounting and money-management systems of social enterprises. Their data is often not well collected and their relation with the financial sector is usually at best passive;
- deficiencies in accountability and responsibility structures, which often obscure who takes the final decisions and who carries the responsibility;
- difficulties with government finance, be it in the form of grant aid that creates dependency, or in that of contractual relationships for service delivery, where full-cost recovery may be impossible;
- and as a consequence: the lack of ability (and possibly the will) of social enterprises to plan and act in terms beyond immediate contracts or their inability to react rapidly to emerging needs or opportunities.
Similarly on the supply side of finance, recurring deficiencies have to do with:
- lack of knowledge if not outright apprehension of this sector and anything “social”. Any form of “social economy” does not fit into an often simplistic view of bankers who tend to separate the social (which is for charity or the welfare state) from the economic;
- lack of understanding of the specific risks (or lack of risks) of the social economy sector;
- restrictive banking regulation on guarantees (e.g. the Basel 2 regulations). This need not necessarily to be so, but would require banks to take a systematic approach to the sector.
How EQUAL has approached the issue – examples
Adopting an appropriate legal form
The legal form in which an enterprise is incorporated can help or hinder fundraising. The Greek legal form of the KoiSPE (limited liability social co-operative), which the Synergia EQUAL partnership helped to launch, provides for corporate bodies to buy investment shares. This in effect allows local authorities and hospitals to inject working capital into new enterprises employing ex-mental hospital patients.
The law provides a legal form for an enterprise benefiting a specific target group, with specific provisions as to its organisation and means of operating. It is an outstanding example of social enterprise dedicated to a single target group. The KoiSPE has the unique feature of being an independent trading enterprise, whilst still being an official mental health unit that can benefit from the loan of National Health Service staff, premises and non-monetary resources. Workers in a KoiSPE can earn a wage without losing their disability benefit, and corporate bodies can contribute working capital by buying additional, non-voting investment shares.
Law 2716 of 1999, article 12, provides that a KoiSPE has the following characteristics:
- independent legal and tax status as a business, trading with limited liability
- retention of supervision by the Ministry of Health
- permission to carry out any economic activity
- exemption from all existing taxes except VAT
- three categories of members: people suffering from mental illness (>35%); mental health professionals (<45%); other individuals and sponsoring organisations (<20%)
- two of the seven-member board come from the user category
- users may earn a wage without losing their benefit payments
- each member buys one voting share (typically worth €175) and may also buy additional non-voting investment shares
The need for collateral support is seen as a major obstacle to credit. In addition to using guarantee schemes, EQUAL has demonstrated two ways for the financial sector to deal with this risk. As mentioned above, the first is to substitute a detailed knowledge of the person and the viability of the project with regard to material guarantees, with support services using various methods for simplifying and unifying the documents required for business plans and applications.
The second method is to substitute individual guarantees with group or peer pressure which has been explored by ADIE with migrant women in France. Many of the same schemes also favour "step lending" – starting with relatively small loans, which are renewed progressively after short periods.
Community development financial institutions set themselves the goal of financing people and organisations that are not primarily out to make a profit: rather, the returns come along a number of dimensions, not only economic but also social and environmental. At first sight this may seem to be a problem, which might lead to difficulties such as a ‘head in the clouds’ attitude and a lack of focus on profitability and generating sufficient of a surplus to allow repayment. However enterprises that are for ‘more than profit’ have compensating advantages – the level of principle and personal commitment and the close trust relations that characterise social enterprises can in fact make them very good risks.
The social capital they possess can be ‘banked on’ in two ways:
- Using human collateral: In order to enable investment in enterprises by people without their own capital, loan funds must find ways to reduce the risk of default. These often repose on the social capital, the trust between individuals that exists in social enterprises. Loan funds for social enterprises such as ICOF (UK) succeed with low failure rates even at national level, despite demanding no physical security for their loans (they take a fixed and floating debenture but no personal guarantees). Factors in their successful record may include the monitoring method, which is close, personal and in harmony with the business’s social objectives, and the deterrent effect that loss of reputation can have within a defined movement and business community.
- Guarantee communities: Networking effects among a community of social investors can also be turned to good account: Triodos Bank, which is active in the Netherlands, Belgium and the UK, asks for a group guarantee: each borrower should assemble a community of 100 supporters, each of whom will guarantee 1/100th of the loan.
Careful design of microcredit products
Europe’s most experienced microlender, ADIE (France), uses microcredit as a tool to enable informal traders to join the official economy. It found that it was principally those people who were spending over four-fifths of their time on informal economic activity, and earning over a third of their income in this way, who were strongly motivated to join the formal sector. The project therefore introduced three innovations that proved very successful with this group of clients:
- using word-of-mouth channels within ethnic networks in order to reach out into minority communities;
- developing a tailor-made blend of step and peer lending techniques: loans are made to peer groups of three people, and usually start very small, at around €1,000, but once they are repaid they can increase in small steps up to €5,000;
- designing a support package involving both individual and group modules on financial capacity building, which cover household budget management, the risks of consumer loans, calculating income and expenditure, stock and cash flow management and so on. The package also includes games on stocks and margins and how to manage one’s personal budget. Additional modules were designed to help the clients to plan their business and assess the risks and benefits of becoming self-employed or registering a business.
Combining multiple revenue streams to create multiple added value
As far as social enterprises go, use should be made of one of their principal distinguishing features, which is that they combine multiple types of resources to create multiple outputs.
For instance they might receive not only income earned from sales to individuals or companies, but also fees for contracts with public authorities, grant income for providing pubic benefits, plus donations of money or facilities and voluntary time. Corresponding to this they might be producing: (a) goods and services for personal consumption, for instance fair trade coffee or elderly care; (b) labour market integration services recompensed by a wage subsidy; and (c) other services, for instance waste recycling, paid for under a contract with the local authority. They are working with a triple bottom line, creating added value not only financially but also socially and environmentally.
This has been conceptualised as the kleefblad or 'cloverleaf' model of financing. For example a neighbourhood services company such as Buurtinitiativen Kuurne (BIK) in Flanders, part of the Werk.Waardig EQUAL project, mixes four classes of revenue:
e.g. wage subsidy for hiring risk groups such as LTU, compensation for lower productivity and/or extra guidance
| Client / user charges |
(plus sometimes consumer subsidy through service vouchers)
| Other policies:
e.g. childcare, home care, tourism, mobility, culture
| Local authority: |
e.g. social tender for community added value, cohesion, community development, poverty
Furniture recycling social firms such as Bulky Bobs in Liverpool also makes a profit by combining four revenue streams: from the collection of bulky waste; from the reduction in landfill; from the vocation integration of disadvantaged people; and from the sale of renovated furniture.
When global economic conditions restrict the supply of credit, and among poor communities, the official currency is, by definition, in short supply. Nevertheless people still have skills and possessions and skills that they wish to exchange. People’s welfare can be increased by injecting liquidity into the local economy – by introducing an additional means of exchange. This may be in the form of a barter scheme or a local complementary currency, often referred to as a local exchange trading scheme or LETS. By providing a means of exchange, such local currencies stimulate the circulation of wealth, to the benefit of both consumers and producers – particularly micro and small businesses, which depend on local markets.
The SOL project, promoted by the Chèque Déjeuner co-operative as part of EQUAL, is piloting an alternative currency that goes further than most such schemes by cleverly combining three roles: loyalty card, local barter scheme and service voucher. Its launch under EQUAL seeded the growth of a national network, the Sol Network. The card is operating in seven French regions where 18,000 users are able to get a bonus on their purchases, and swap services with their neighbours. The SOL also offers local authorities a way to target their services to those who need them most.
The SOL combines three different types of money:
- The Co-operation SOL (SOL Coopération) acts like a loyalty card and is calculated in euros;
- The Commitment SOL (SOL engagement) aims to make voluntary work visible and accountable, and is calculated in time;
- The Dedicated SOL (SOL affecté) is a voucher given by the public sector to specific target groups, allowing them to access specific goods or services.
Not only is the project innovative in using chip cards, the internet and mobile phones, but it also aims to introduce a new concept of wealth not based exclusively on money. See also case study prepared in 2006.
Recommendations for mainstreaming policies
Microcredit can prove successful in increasing the incomes of marginal traders. However there is still a high threshold that must be overcome before informal traders earn enough to be able to join the formal economy. If the objective is to reduce the informal economy, ways to make the transition from the informal to the formal economy less onerous, both bureaucratically and financially, should be found.
Links to EQUAL case studies
- Accelerating Women’s Enterprise - AWE (UK): http://ec.europa.eu/employment_social/equal/data/document/etg2-suc6-awe.pdf
- Synergia (GR): http://ec.europa.eu/employment_social/equal/data/document/etg2-suc6-synergia.pdf
- ADIE (F): http://ec.europa.eu/employment_social/equal/practical-examples/entrep-07-proxy_en.cfm
- Werk.Waardig (B): http://ec.europa.eu/employment_social/equal/practical-examples/entrep-07-werkwaardig_en.cfm
- SOL (F): http://ec.europa.eu/employment_social/equal/practical-examples/entrep-07-sol_en.cfm
- Finances et pédagogie (F): http://www.finances-pedagogie.fr/
- Survey of financial literacy in EU27 (Evers and Jung, 2007): http://ec.europa.eu/internal_market/finservices-retail/docs/capability/report_survey_en.pdf
- Financial Services Authority (UK): http://www.fsa.gov.uk/
- Fair Finance (UK): http://www.fairfinance.org.uk/
- Let’s Talk about Money – Your Money Guide (UK): http://www.letstalkaboutmoney.org.uk/
- Co-operative & Community Finance (UK): http://www.icof.co.uk/
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