Two InFiNe.lu members were granted a scholarship to attend the Boulder Microfinance training 2016. Olivia Fechner (ADA) and Anita Kover (Innpact) are telling us what is this training by explaining some of the classes they are attending. Here is their Week 3, their last week, report.
This week, the masterclass was led by Emilio Hernandez, an Agricultural Finance Officer at the FAO, with a long experience in the analysis of rural/agricultural financial markets in developing countries and in the implementation of technical cooperation programs that promote inclusive financial systems.
For the last week, the masterclass sessions aimed at putting all together the studies and cases we have reviewed since the beginning of the program, the common question being: what is the role of rural and agricultural finance in the financial inclusion agenda?
First, it is interesting to consider that according to FAO data, the majority of the financially excluded population lives in rural areas and have livelihoods where agriculture plays an important role. Furthermore, it appears that there is a correlation between the rurality of a population and its level of financial inclusion: according to the FAO data, we can observe that the more rural is a country, the more its population is financial excluded.
Financial inclusion in general facilitates greater resilience and movements out of poverty, which are especially relevant for rural household’s dependents on agriculture. We have seen during the first week, through the financial diaries study conducted by CGAP (see article above), that agriculture does not represent the majority of the income generated by smallholder households but plays an important role and that this specific segment has many and different unmet financial needs:
All these needs represent an undeserved markets for MFIs. Therefore, we tried to understand how MFIs can tackle with this segment, based on the experiences of successful practioners in the informal sector. To resume, these are some of the key factors we discussed:
• Choose an entry point, based on its comparative advantage
• Diversify financial services (general/specialised financial services)
• Diversify clientele in rural areas (to reach a higher volume and therefore economy of scale)
This course was given by A. Stoppa, an agriculture economist active in the fields of agricultural policy and risk management. He has provided consulting services to various private and public institutions, among which The World Bank, WFP, IFAD and FAO.
One of the elective courses I had chosen for the first week was Risk Management in agriculture financing. During this course, we had reviewed different risk management strategies that can be used by the farmers and financial instructions. One of them, is to transfer the risks through insurance contracts.
Insurance can be a powerful solution for managing agricultural production risk and therefor for making governments and financial institutions more willing to invest into agricultural activities. During this course, we first analysed the functioning of traditional agricultural insurance (indemnity based insurance) cost structure and what determine the premium price. We reviewed crop insurance and livestock insurance mechanisms.
However, in many developing countries, it is still challenging to implement agricultural insurance solutions and to successfully deliver products that can meet the requirements of all parties involved in the risk transfer transactions. The main challenges that are faced by agricultural insurers to work in developing countries are:
In comparison, insurer companies have many more profitable opportunities in commercial and urban areas.
To deal with these issues and to reduce the transaction costs, some index based insurance initiatives have emerged. It is an innovative way of offering micro insurance services to smallholders at a lower cost: instead of analysing the situation and damage of each person, indemnity payments are based on an index. In this context, an index can be defined as a variable that is highly correlated with losses and cannot be influenced by the insured. In this case, pays out are determined by the value of the index instead of being based on losses measured individually in the field…. It is an objective and transparent way of doing micro insurance which generates rapid payments after a triggered event. Also, one of the big advantage for the insurance firm is that it reduces the asymmetric of information (clients cannot hide or lye about their situation as the index is independent) and incentive risk (in this case, farmers are still incentived to do their best to have a successful crop because the payout is based on an external trigger and not on the specific damage of one client, as it is the case in indemnity based insurance).
Index based insurance can be split into 2 groups: weather index based insurance (in this case the trigger can be rainfall, temperature, wind…) and area yield insurance (in a defined area, area yield index insurance provides payouts when the average yield of an area falls below a specified threshold).
However, index based insurance still have to deal with some issues:
It is also interesting to consider that an insurance policy subscriber can be a government/community (macro level: a government buys an insurance and distributes the indemnity in case a reverse event occur), a financial institution (meso level), or the farmers (micro level). Therefore, it encourages public private partnership.
This course was given by A. Szebeni, a consultant to the Rural Finance team and the Investment Center of the Food and Agriculture Organisation of the United Nations where he is involved in providing technical assistance to Member States.
This course aimed at discovering and using an Excel tool designed for loan officers to analyze agricultural loans. The specificity of this tool is that it makes possible to conduct a very flexible cash flow analysis related, to crop/livestock activities and commodities prices, which allow loan officers to have a better picture of the client’s payment capacity.
During the first session, we discussed over the challenges of agricultural loan appraisal (volatile inputs/market prices, information gap…). We then get familiarized with the tools thanks to some case studies to understand how to enter and report the data into the Excel sheet and then how to use all the different ratio to determine the adequate loan terms.
One of the Master classes this week was conducted by Michael J. McCord, a highly respected microinsurance leader, and the president and founder of the MicroInsurance Centre, LLC, a consulting firm specialising in research, advocacy and designing microinsurance products and processes that meet the unique needs of low-income clients.
Insurance covers an individual / company / household for some or all of a financial loss that is linked to an unpredictable event or risk, such as the loss of assets, deaths or illnesses and natural disasters via risk pooling and the payment of a premium.
Looking at numbers, the potential for microinsurance is striking. For example, in Sub-Saharan Africa, insurance penetration stands at less than 5% (2015 data).
What is value in microinsurance poverty alleviation?
By buying insurance, the client also “buys peace of mind” that will enable him or her to make decisions that may be riskier and better in the long term, as they are less affected by the psychology of scarcity described in my blog entry summarizing the “Poverty lending and viability” class.
Access to services
People having health insurance go to the hospital faster (on average 2 days vs 5 days based on studies conducted in Uganda and South Africa), so they experience less of a crisis and recover more quickly.
Financial value
By definition, insurance reduces the financial burden of unexpected events. During the class, we discussed a study conducted in Colombia on the role a funeral insurance policy can play in coping with the financial consequences of a family member’s death.
Both the insured and the uninsured used different resources to pay for the costs: savings, income, informal loans, gifts, reduced consumption. While most of the uninsured were able to cover the full cost of the funeral, doing so compromised their ongoing financial wellbeing: they depleted all their savings and accumulated significant expensive loans. In contrast, the insured families covered most of the expenses by the insurance benefit, and they did not rely heavily on the most burdensome financing strategies.
We concluded the class by a reflection on client centricity in the design of microinsurance products, the impact of which should be measured by how they change people’s opportunities.
During this course conducted by experts from CGAP, we explored trends and issues around financial inclusion as a policy objective.
There has been a vocabulary shift away from microfinance toward access to finance and more recently towards financial inclusion. I found it very helpful that we started the class by defining the terminology.
Microfinance refers to the provision of formal financial services (credit, savings, payments, insurance, and investments) to poor and low-income people, as well as others systematically excluded from the financial system. Financial inclusion refers to a state in which all working-age adults have effective access to these financial services provided by formal institutions. This definition captures all financially excluded and underserved customers, including households that are not considered poor by local standards, as well as SMEs. Effective access involves convenient and responsible delivery of services that are responsive to the needs of these customers, at a cost affordable to the customers and sustainable for the providers. The demonstration of effective access is sustained usage. So the fact that a customer can access services offered by a formal financial service provider does not mean she or he is “financially included”.
We then identified the four key financial sector policy objectives, which collectively spell the acronym “I-SIP”:
We continued by exploring linkages among these policy objectives. More specifically we looked into how inclusion affects stability, integrity and protection.
Firstly, an inclusive financial sector will have a more diversified and stable retail deposit base as well as less concentrated credit portfolios, thereby reducing systemic risk and increasing stability. It is also more likely to have a greater political legitimacy, and thereby decrease the risk of social and political instability.
In addition, greater inclusion brings more transactions from the untraceable world of cash into the traceable electronic world. In fact, the Financial Action Task Force (FAT), the international standard-setting body for AML/CFT, has formally recognised financial exclusion as a money laundering and terrorist financing risk.
Furthermore, inclusion increases capacity to apply and enforce consumer protection norms – after all, users of informal financial services are by definition unprotected. It also expected that awareness of consumer protection in formal finance will increase uptake and usage.
The most important take-away from this course for me was that bringing people into the formal financial sector would not only improve their lives, but it would also contribute to the soundness of financial systems themselves. Indeed, based on this realisation, recently new global actors have emerged with a focus on financial inclusion, such as the G20’s Global Partnership for Financial Inclusion or the UN Secretary General’s Special Advocate for Inclusive Finance for Development.
We started this course by defining financial market actors at the micro, meso, and macro levels as an introduction to the so-called market systems approach to financial inclusion, which we then explored in detail and applied through case studies.
The market systems approach is a combination of frameworks, principles and practices that can be used to frame development interventions that lead towards systemic change, rather than filling a void in the market. Historically used in other sectors, for example, agricultural value chains, it has been increasing gaining the interest of funders and practitioners in the field of financial inclusion. This approach aims to catalyse systemic change by addressing the root causes of financial exclusion and not only its symptoms.
We discussed that funders need to think of their role not as providers of missing services in the market but rather as facilitators who incentivize and enable market actors to provide these services by performing their market functions more effectively.
I could link this conceptual model with the discussions at the other course I attended during the same week “Inclusive Policy, Regulation, Supervision and Compliance”. While the latter looked at the policy perspective, this course focused on the funding perspective, but they both identified that ac¬cess to and use of formal financial services can have a broader positive impact on national economic development, a development objective shared by funders and policy makers alike.
Moreover, it was exciting to me to relate this market systems approach to the increasingly divers and innovative impact finance initiatives Innpact is involved with.
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Picture 1 © Pallab Seth