Microfinance in the Wake of Natural Disasters: Challenges and Opportunities
by Geetha Nagarajan
Many microfinance organizations (MFOs) now working in disaster-prone countries have been caught up in natural disasters as they have occurred and have become active players in post-disaster situations. This paper documents the experiences and experiments of MFOs that have found themselves on the front line in natural disaster situations. The author synthesizes the lessons learned from such situations and makes recommendations for donors, policy makers, and MFOs.
If an MFO is to succeed and protect its clients in the wake of a natural disaster, the following conditions must be met:
The success of an MFO's services following a disaster depends on a number of factors. Most important are the timeliness of the intervention, the length of time the MFO offers various services, the types of financial products the MFO provides, the MFO's ability to coordinate its services with those of other relief organizations, and loan terms and conditions. (For example, to maintain its viability, an MFO should never pardon loans at any stage of a post-disaster situation. In some cases, however, loan write-offs can occur, such as when a client is killed or unable to be located.)
Established MFOs. Established MFOs can provide relief activities immediately after disasters, but the period during which they offer such assistance should be brief and followed by unsubsidized loans in the rehabilitation and reconstruction phases. Any MFO activities during the relief stage require coordination with other relief organizations to ensure the quick and accurate flow of information and services from all players. Successful MFO activities during the rehabilitation and reconstruction stages depend on timely intervention. During these stages, emergency loans, allowances for withdrawal of client savings, and rescheduling of debt may be more important than providing clients with new loans for housing or asset replacement. New loans can most successfully be made about six months after the disaster to clients who have proved they can manage the disaster through other means.
New MFOs. Institutions created in response to disasters provide social services, technical assistance, training, and limited financial services on a grant or soft-loan basis to affected populations; they are unable to recover operating costs during the period in which they offer these services. Such organizations can, however, successfully transform themselves into cost-recovering MFOs once donors shift their focus to the development role of finance. To do so, they require significant seed capital from donors.
New MFOs should be created after the relief and early rehabilitation stages are over, so that they can better screen applicants and make higher-quality loans.
Providing services in post-disaster settings entails both high direct and indirect costs: high direct costs because of poor logistics; high indirect costs because of reduced savings levels and lower repayment rates. New MFOs encounter more difficulty than established organizations when serving the same disaster-affected population, as it takes longer for new MFOs to reach financial sustainability than it does existing MFOs. The initial costs of servicing loans in post-disaster areas are very high for new MFOs but can be reduced somewhat by involving the community in making new loans.
For established MFOs, the costs of operations are lower when the client base serviced during the post-disaster period consists largely of repeat borrowers. Among repeat borrowers, the more experienced are most likely to avoid defaulting after disaster strikes. Most important, established MFOs that have previously experienced natural disasters find that their costs of operations in post-disaster situations drop considerably as their preparedness increases.
In terms of the cost of specific financial products, housing and asset-replacement loans for rehabilitation and reconstruction are likely to be cost-recovering only if provided in a timely way. Meanwhile, insurance services to protect clients or portfolios from chronic disasters require subsidization, either by donors or through cross-subsidization with the MFO's other financial services.
Successful program design for post-disaster settings requires careful risk management that minimizes loan defaults and other financial losses. Geographically concentrated MFOs with a limited client base cannot manage risks on their own through mechanisms such as loan rescheduling or new loans. Rather, such organizations must delegate risk management to their clients through enterprise-diversification schemes or group-level contingency funds that insure against the group's risk of disaster. Diversification to minimize risks also demands careful examination of group lending practices. Group lending with joint liability may suffer from covariance effects and domino defaults, whereby one defaulter can pull the entire group into default. In addition, group-based programs with equal loan sizes and joint liability are unattractive to clients during the rehabilitation and reconstruction phases. These factors argue for individual lending in drought-prone areas.
Successful program design also demands that governance structures be stable. Cohesive groups headed by strong leaders tend to repay loans better in a disaster setting than do groups headed by weak leaders. Similarly, MFOs with strong executive committees are better able to cope with natural disasters, avoiding both political influence and mismanagement of funds. Finally, sound program design requires an understanding of the nature of the disaster in order to provide effective services.
Role of the MFO in Relief, Rehabilitation, and Reconstruction MFOs may provide emergency services to clients (such as food, clothing, shelter, and medicine) until other relief agencies arrive. Sometimes such services are provided to all individuals in the affected communities, albeit on a limited basis.
Established MFOs have developed disaster-management funds to help clients cope with emergencies. In addition, an MFO's promise of post-disaster loans for reconstruction or asset replacement is viewed by the organization's members as a form of disaster insurance.
Despite their role in protecting clients in times of disaster, MFOs cannot serve as social safety nets for the entire vulnerable population in their service areas. MFOs may provide temporary relief services on a non-exclusionary basis, but rehabilitation and reconstruction services are available only to previous clients of established organizations and selected clients of new organizations.
Disaster Preparedness and Portfolio Protection
New and small MFOs have fewer mechanisms available to protect their portfolio than do large and established organizations. This is because, in addition to lacking experience, small and new MFOs have a small clientele, limited geographic coverage, lower levels of capitalization, and less experienced or less desirable clients.
Development of disaster-contingency plans and client-preparedness training during normal times is one of the most important instruments to protect a portfolio in post-disaster times. Staff training in disaster-management exercises and early-warning systems is effective in assessing disaster situations quickly, anticipating portfolio risk, and preparing for disasters. Portfolio protection requires exact post-disaster accounting procedures. Absence of such procedures can prevent an MFO from being able to measure damage to its portfolio. This is particularly true for programs that allow withdrawals and subsequent repayment of savings in addition to loan acquisition and repayment.
Some strategies are ineffective in protecting portfolios during a disaster. For example, loan rescheduling, as noted above, is an ineffective mechanism for recovering old loans not backed by tangible collateral. Similarly, simple state-contingency contracts undermine the credibility of MFO collectors, thereby reducing the institution's ability to protect its portfolio from high post-disaster defaults. State-contingent contracts can protect portfolios only if they include compensating incentives.
Donors. It is not desirable to start a new MFO during the early stages of a disaster, especially if the MFO is expected to provide social services during the early stages of disaster. Established MFOs are better equipped to deal with early stages of disasters, especially if they have a dense network of branches.
To avoid burdening long-term MFO operations with the costs of relief operations, it is appropriate for donors to provide grant funds for relief operations. If the donor arrives after MFO relief activities have commenced, the donor may compensate MFOs for relief expenditures so that the MFO is fully capitalized to begin rehabilitation and reconstruction loans in the later phases of disaster recovery. In no case should donors encourage MFOs to make financial grants to clients or wipe out previous debts. Clear exit dates should be specified for any disaster-related grant facility. No activity aimed at disaster relief should extend into the later part of the reconstruction stage.
Donors can provide seed capital to established MFOs during normal periods to form disaster-management funds. Such funds can sustain operations immediately after disasters before fresh donor funds arrive. Donor funding can also be used for training MFO staff and clients in disaster preparedness. Donors may encourage research on disaster-proof products within the financial technology, the costs and timing of post-disaster activities, risk-balancing mechanisms for MFOs, and insurance programs to improve victims' ability to cope. Donors are also well positioned to disseminate information on MFO disaster-management and disaster-mitigation strategies. Policy Makers. Even well-established MFOs play a limited role in providing safety-net services to disaster victims, and even then, services are primarily targeted to the MFO's clientele. Government grants can be channeled through MFO networks only if the MFOs can manage the provision of relief grants along with their credit programs. In any case, the grant operation should not undermine the reputation of the MFO as a prudent financial intermediary. In addition, coordination among the several agents active in the post-disaster situation should be encouraged and actively supported.
Policies such as loan wipe-outs should never be used because they jeopardize MFO viability and do not benefit non-borrowing victims. MFOs. Any MFO relief activities should be brief and should not involve loans or financial grants. When MFOs play a role in disaster relief, they should announce to their clients that the services are only short term. The community needs to understand that (1) the relief services are funded by the government or donors, and the MFO is functioning only as a short-term agent to deliver those services; and (2) relief activities are not the MFO's main line of business.
MFOs should use separate windows and special names for disaster-management financial products and programs to distinguish disaster activities from regular activities. The special windows and special products should be used for only a specified time.
A comprehensive disaster-preparedness program, implemented during normal times, may be one of the most effective tools to help MFOs deal with disasters in a systematic and sustainable way. As noted earlier, another effective tool for portfolio and client protection is diversification of member enterprises and the MFO portfolio.
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