In the previous articles on the introduction to microfinance which was followed by sources of funding to the Microfinance Institutions (MFIs), we continue to deepen our knowledge in the field. We shall continue today with lending methodologies and look at how they help in developing clients upwards in poverty reduction.
These refer to how the loans are offered to the general public. How are the clients identified, selected, grouped, and which methods are selected for the offering of services to the clients or customers in general! In this wise, we shall focus on group loan and individual loan methodologies.
Group Loan Methodology
Group lending terms from the understanding that customers from low-income level could not afford collateral for an individual loan. They form a group to borrow so that each guarantee for the other. This was the origin of the idea dating back to the birth of microfinance in the 1970s. This is also called the solidarity or the Grameen method. Grameen itself means ‘village’ or ‘rural’ in the Bengali language of Bangladesh, which the father of microfinance, Professor Muhammad Yunus gave to the concept or the methodology. Therefore, the group loan methodology is generally referred to as the Grameen method of lending. This methodology later spread to Latin America and Africa among the MFIs.
The group may be composed of 3 to a number determined by the MFI. The majority of groups in various MFIs range between 5 and 30 members. Each group must have a leader or chairperson, a secretary and a treasurer. The groups are to choose their own leaders and also accept and expel members. This ensures internal rules, regulations and discipline in the group are followed. The MFI only guides the group but does not decide for the group.
On group composition, groups may be comprised of only dealers in the same or similar type of business (example, tomatoes sellers only) or a mixture of varied businesses (example, food sellers, second-hand cloth dealers all in the same market/location). Also, the amount borrowed per each member in the group could be the same or varied amounts. There are advantages and disadvantages of each of these group composition which affects the group dynamics.
Each person guarantees for the other in the group. On the repayment day, all members must contribute and pay according to their loan schedule. In case one or a few members fail to meet their repayment on the due date, the rest must contribute and pay for those members who couldn’t pay. That is the meaning of the solidarity or the Grameen method. No default is allowed on the repayment date.
A member who continuously defaults thereby incurring the displeasure of the members is normally expelled from the group in the next cycle of the loan.
In general, the groups that have been existing for a long time normally reduce in number. This is the point that the MFI comes it to ‘reward’ the loyal members with an individual loan, but not before. In many organisations, the group may become smaller after their tenth cycle of the loan. That is if the group have collected and repaid ten times in the loan cycle of between 6 to 10 months, the group is regarded as a matured group! It then graduates to an individual loan stage.
Individual Loan Methodology
In the individual methodology, clients are regarded as independent, can manage their own cash flows, and run their businesses effectively without any group/peer pressure. The majority of clients here graduated from the group loan methodology. Other MFIs also just jump clients straight to the individual methodology without first passing through the group stage.
This depends on the assessment of the client’s business and the confidence built in what the client does for business after the credit assessment scoring process.
Let’s look at the following characteristics of Individual loans in comparison to the group loans: –
- Interest rate for the individual loan may be higher than that of the group loan
- Collateral may be required in many instances as there is no group guarantee system for individual loan
- Individual loan is considered riskier than group loans as much defaults are experienced here than that of the group loans
- In general, men prefer to go for individual loans as compared to the group loans that are normally dominated by women
- Stringent assessment and credit scoring is applied to the individual loan than the group loans
- The client must be in business for a given number of months to qualify. While this also applies to the group loans, the success and continuity of the business is much of importance here than the collateral offered
Next time you will like to borrow from an MFI, consider whether you will like to go solo, that is, for an individual loan or you will like to join a group. If you prefer taking the individual loan, are you prepared for all the requirements and will you follow suit?