Hannover B4 microfinance & support
Hannover policy forum background paper
Workshop B4 - LINKING SUPPORT AND FINANCE
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- To recognise the importance of finance as a key element of micro enterprise development
- To understand how finance needs to meet varied needs in diverse client groups
- To explore how to meet the challenge of scaling up financial support in the next period
What is the challenge?
There is a recognised finance gap for small and micro businesses. The EU defines micro lending as loans of less than €25,000 but in reality many businesses need even smaller amounts of capital – in some cases as little as €1,000 to set up their business with the majority being around the €5,000 level. The problem is that the smaller the loan the higher the proportion of transaction costs. This makes it hard to make such clients viable for the traditional banking sector.
The second problem is risk. Banks use elaborate scoring methods based on credit histories to assess personal lending. But with lending to small enterprises and especially start-ups, there is no track record or reliable business plan to lend against and unsupported micro enterprises have high failure rates in the first three years.
At the European Micro Finance Network conference in Berlin in April 2007 representatives from BNP and Deutsche Bank made it clear that global banks see micro lending for micro enterprise as a business for other people – either savings banks or the emergent micro credit institutions. For the big banks this segment is too risky and has too high transaction costs to be a good market. They big banks are, however prepared to act as wholesale lenders to smaller institutions that have developed techniques to lend to micro enterprises.
Considerable resources at Member State level are spent on providing grants to start up businesses although budgetary constraints and poor results of many grant schemes are leading many to shift towards lending based approaches. Some Member States have flexible ways of capitalising future welfare benefit streams to enable an injection of working capital at the start-up phase for those leaving benefits for self-employment, and these could be a source of support to micro lending with recognition of the savings to the public purse gained by helping a benefit recipient into self-employment.
All micro enterprises face problems with credit but this is more acute for people who are disadvantaged because they are less likely to have access to ready sources of capital or security for a loan. Studies also show that ethnic minorities refer to difficulties in accessing finance as the most important barrier to setting up a business. It is also a significant problem for women and for young people. As a result informal sources of finance play a major role in the start-up market. Start-ups do obtain finance but often from family and friends and this often acts as a constraint in the medium term.
Although the micro finance institutions offer hope in this area – the scale of their operations is often small in relation to the number of micro enterprises that need finance. ADIE has grown its capacity and coverage to provide 7000 loans per year across France since the early 1990s when it started. Eastern Europe has a strong tradition of micro finance since 1989 for example Inicjatywa Mikro in Poland makes over 5,000 loans per year with an average loan size of below 3000 euros to a mixture of start-up and existing businesses. The new generation of institutions such as Un Sol Món in Catalunya and Fair Finance in London make about 300 loans. Fair Finance has a high proportion of ethnic minority and women borrowers and Un Sol Món increasingly lends to recent migrants.
Within the EU member States very large variations exist in the regulatory framework for micro lending. Some Member States such as Germany have always required that banks do the lending. Similarly there are very different rules about maximum interest rates because of strong usury laws in some Member States. In France this was also the case until the regulatory window was established under pressure from ADIE to enable micro finance institutions. Many of the new institutions in Spain are lending at just over the bank rate – typically 6% in 2007. This is too low a rate to enable the institutions to become financially self-sufficient. Interest rates of around 20% are likely to be needed to achieve financial self-sufficiency and even then this rate will not generate enough income to cover advisory services. State-supported lending or grant schemes to start-up businesses often have the perverse effect of destroying the market for emergent micro finance providers.
A further problem is that finance by itself is not the solution as it has been in the developing world. There are high regulatory barriers to entry in the EU 27 countries. Micro enterprises need sophisticated advice and support services to help them to navigate tax, social security and regulatory issues. Without financial advice many micro enterprises are not ‘investment ready’.
In the last funding period the EU became more engaged in microfinance. The importance of entrepreneurship and micro credit was highlighted by the European Council in March 2003. The European Investment Fund now has a micro credit guarantee ‘window’ and DG Enterprise has included micro credit in the Action Plan on Entrepreneurship. Meanwhile the use of the Structural Funds for micro credit has grown in a decentralised way in national ESF programmes and Regional programmes although much of this support is aimed at larger SMEs through risk capital instruments.
What solutions are being tested?
Within EQUAL there has been an increased emphasis on finance in later rounds of the programme. Much of this has not been about financing the loans themselves but adapting schemes to the needs of specific target groups. Valuable work has been done around groups including women, ethnic minorities and migrants. Some of the generic themes include:
- Action research on the experience of the target group and their financial needs – a recognition that there are no ‘standard’ clients and diversity is very diverse (e.g. between different migrant groups)
- Adapting financial products and methods to the specific needs of clients
- Mentoring - creating a sensitively designed package of mentoring and business support to link with financial initiatives. Equal has worked to better define mentoring and develop common standards, quality control systems for mentors and benchmarks.
- Financial literacy and financial capacity building is essential for both micro entrepreneurs and social enterprises that have complex finance issues.
- Partnerships to bring in organisations with financial, business and social expertise – here each partner brings their own expertise, for instance in Spain the social services bring knowledge of the target group while the specialist lender does the lending.
- Maximise financial sustainability by bringing fragmented initiatives together (e.g. DMI in Germany brought together 22 operations to create the Deutsches Mikrofinanz Institut (DMI) with a single fund able to access EIF guarantees, and by segmenting activities by seeking high levels of self-sufficiency (based on income from loans) for the lending operation but seeking funding for the business support element.
- There is continued work on regulatory and framework conditions (informal economy, progressive tax, migrant worker status, welfare bridge, banking regulations)
- Is integrated support and finance the best model or should each side do what it does best?
- Who pays for financial literacy, financial capacity-building and linked business support?
- How can successful initiatives be scaled up in the new period?
- How can organisations manage complex funding environments for themselves while presenting a simple user interface to the client?
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