Committee of Donor Agencies for Small Enterprise Development,
Donor's Working Group on Financial Sector Development
The following document is included to give all organizations
initiating microfinance activities, guidelines as to what donors have learned and expect in terms of
It is a joint product of the Donor's Working Group on Financial Sector Development
and the Committee of Donor Agencies for Small Enterprise Development. It was inspired by and is
largely consistent with the recommended standards for support set out by a UN expert group of
leading small and microenterprise practitioners convened by Women's World Banking in January 1994.
The donor committees adopted the principles in their current form in June 1995, following
consultations with key donor agencies involved in small and microfinance. This document is intended
for use by project officers in donor and implementing organizations, managers, and policy makers.
The purpose of these principles is to establish common standards for
donor agencies to apply in supporting broader access to financial services for micro and small
enterprises1. Such enterprises have historically lacked access to the formal financial system, but
the growing success of many institutions provides confidence that access can be provided
sustainability in many settings. It has now become possible to identify and agree upon the basic
principles that support successful micro-level finance, so that donors can work in concert to ensure
that lessons of success are translated to the institutions they support.
The framework for donor support to micro and small enterprise finance centers on two
equally important and complementary objectives. First, outreach embodies the aim of expanding
access to increasing numbers of low-income clients. Second, sustainability provides the means to
expand and maintain outreach. These concepts underpin the guiding principles described here.
Different types of micro and small enterprise clients have different
characteristics and demand different services. Hence it is desirable to encourage a range of
institutions that use specialized methods to serve their particular market niches. These can
include commercial and development banks, credit unions, mutual or community banks, non-governmental
organizations (NGOs), finance companies, cooperatives, savings and credit associations, and other
specialized intermediaries. At the same time, however, this document is based on the premise that
fundamental principles of finance apply widely and must be observed by all institutions if they are
to succeed. Moreover, donors must design their support mechanisms in ways that are consistent with
best international practices and long-run development of a sound financial system.
This statement of guiding principles first identifies characteristics donors should
seek in selecting institutions to support. It then describes appropriate forms of donor support.
An annex lists reporting standards on outreach and financial performance.
I. Institutional Performance Standards and Plans
Intermediaries seeking support
should be able to demonstrate the following characteristics, either in current operations or through
credible plans underpinned by concrete measures. Since institutions are at different stages of
development, it may be appropriate in some cases to adopt modified standards for limited support to
new or transforming institutions.
A. Institutional Strengths
1. Institutional culture, structures, capacities, and operating systems that can
support sustained service delivery to a significant and growing number of low-income clients.
Requirements include a sound governing structure, freedom from political interference, good fit to
local context, competent and stable staff, a strong business plan for expansion and sustainability,
and mission and vision which create a sense of purpose, ownership, and accountability.
2. Accurate management information systems that are actively used to make decisions, motivate
performance and provide accountability for funds. Such systems are essential for effective and
3. Operations that manage small transactions efficiently, with
high productivity, as measured by variables such as loans per staff and operating costs as a
percentage of average annual portfolio (while maintaining portfolio soundness).
4. Meaningful reporting standards. Transparent financial reporting that conforms to
international standards and allows prospective funders to evaluate performance adequately. At a
minimum, the raw data listed in the Annex should be reported, and institutions should regularly
monitor financial condition using appropriate financial ratios derived from such data.
B. Quality of Services and Outreach
on the poor. Evidence of service to low-income clients, women and men, especially clients lacking
access to other financial institutions. The focus need not be exclusive, as mainstream institutions
such as banks are encouraged to become providers, but it must entail a distinct commitment to
reaching the poor.
2. Client-appropriate lending. For example, for micro-level clients,
institutions should feature quick, simple and convenient access to small, short-term loans, often
short-term, that are renewed or increased based on excellent repayments. Use of collateral
substitutes (e.g., peer guarantees or repayment incentives) or alternative forms of collateral to
motivate repayment. Emphasis on character-based lending for smaller loans, with simple cashflow and
project appraisal for larger and longer term loans.
3. Savings services. Offering
savings mobilization services, where legally possible and economically feasible, that facilitate
small deposits, convenient collections, safety, and ready access to funds -- either independently
or with another institution.
4. Growth of outreach. Making significant progress in
expanding client reach and market penetration, demonstrating both strong client response to services
offered and competence in service delivery management.
C. Financial Performance
1. Appropriate pricing policies. Offering
loans at rates sufficient eventually to cover the full costs of efficient lending on a sustainable
basis (after a reasonable start-up period), recognizing that poor entrepreneurs are able and willing
to pay what it costs an efficient lender to provide sustainable financial services. Interest
charges by the retail unit should be set to cover the costs of capital (at the opportunity cost,
including inflation), administration, loan losses and a minimum return on equity2.
2. Portfolio quality. Maintaining a portfolio with arrears low enough that late payments and
defaults do not threaten the ongoing viability of the institution. For example, organizations with
loans in arrears over 30 days below 10 percent of loans outstanding and annual loan losses under 4
percent of loans outstanding satisfy this condition.
3. Self-sufficiency. Steadily
reducing dependence on subsidies in order to move toward financial self-sufficiency. Achieving
operational efficiency, i.e., covering all administrative costs and loan losses with client revenues
within a reasonable time period, given local conditions. International experience shows that
successful intermediaries have achieved operational efficiency in three to seven years, and full
self-sufficiency, i.e., covering all financing costs at non-subsidized rates within five to ten
4. Movement toward financial independence. Building a solid and growing funding
base with clear business plans, backed by operational capacities, that lead to mobilization of
commercial funds from depositors and the financial system, and eventually to full independence from
Financial performance standards apply only to activities that
are an integral part of providing financial services. If programs also provide non-financial
services, such as business advisory services, health, or education they must account for such
services separately from financial services. Standards for financial self-sufficiency do not apply
to such services, and defining appropriate standards for non-financial services is beyond the scope
of this document.
II. Strategies for Donor Support
Funding based on large,
ongoing subsidies with a charity rationale has failed. Such programs have drained resources without
becoming sustainable, and have contributed to the mistaken notion that the poor are unbankable.
Funders should provide financial and other support in forms that foster the movement to scale,
financial self-sufficiency, and independence from donor support, taking into account the particular
characteristics of different types of institutions.
A. Appropriate Uses for Grants.
1. Institutional development. Support for institutional
development is appropriate at all stages of an institution's life, and for a wide range of
institutions, although the nature and extent of such support should evolve with the institution.
Such support should become more selective, as institutions become able to meet more of their
organizational development needs from within. It should also become more specialized, as
institutions tackle more difficult problems.
2. Capitalization, or grants for equity are of
strategic importance in enabling organizations to build a capital base. Capitalization can be used
to generate investment income, build the loan portfolio, and leverage funds from local banks. One
of the key purposes of providing capital funding is to enable institutions to mix costs of grant
funds with commercial sources during the period it takes to build efficient operations and scale.
Externally-financed capitalization should be used as a catalyst and complement to domestic
mobilization of funds by local institutions. Grant equity contributions can also help institutions
seeking to become formal financial intermediaries to meet minimum capital requirements.
3. Operating losses. Donors should avoid covering operating losses except during a clear,
time-limited start-up or expansion phase. By the nature of the small loan business every program
will take some time to reach a break even point. Donors should be willing to provide support during
that time. Afterwards, however, such support becomes counterproductive.
assets. Donors may wish to support purchase of fixed assets, such as computers, vehicles or
premises. Such funding may be seen as contributions to the equity base of the institution.
B. Appropriate Uses of Loans.
Donor support through loans
is appropriate for lending-based institutions that meet performance standards. However, loan
capital from local and commercial sources should be sought as early as possible, even at start-up.
Care should be taken to avoid burdening young institutions with foreign exchange risk in loans
denominated in foreign currency, unless adequate precautions are taken. Donors are also advised to
be careful not to undermine savings mobilization efforts of savings-based institutions, such as
savings and credit associations by making loans available to them below the cost of mobilizing funds
C. Commercial Sourcing of Funds.
The transition to fully
commercial sources of funding requires special forms of support that help introduce institutions to
the financial system. Donors can act as catalysts to effect this transition through means such as:
1. Investor equity, from both official and private sources. Donor support
can help leverage private investment
2. Second-tier operations, which raise funds from
commercial sources and on-lend to microenterprise finance institutions.
guarantees of loans made by commercial banks to NGOs.
D. Coherence of Donor
Institutions following sound principles for sustainability must not be
undermined by others providing competing services below cost or in ways that cannot be sustained.
When providing subsidies (grant or loan) to small and microenterprise institutions, donors should
ensure that they coordinate that support with other funders, such that institutions are given clear
incentives to become financially viable. In particular, donors need to consult each other
regarding appropriate interest rates and other terms on which assistance to any given institution is
supplied. Donors should also coordinate institutional support with sectoral policies such that
financial institutions, including informal and semi-formal sectors, find enabling conditions for
institutional development and growth.
1 Included in the term micro and small
enterprises are a wide range of enterprises (industry, transport, commerce, services, agriculture,
etc.) ranging in size from part time, seasonal activities of a single person to small, formal
enterprises employing several non-family members.
2 It should be understood that costs of non-financial assistance provided to
entrepreneurs may continue to receive subsidies. However, it is crucial that these costs be
separated from the costs of lending operations, so that the financial viability of lending
operations can be assessed.
This report was prepared by:
Committee of Donor Agencies for Small Enterprise Development,
Donor's Working Group on Financial Sector Development