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WFP / Giulio d'Adamo

Chapter 12.3 Financial mechanisms and services for risk reduction

Micro-credit and micro-finance

Photo: WFP / Giulio d'Adamo

Micro-finance can play an important role in reducing vulnerability before disasters and supporting post-disaster recovery. It can be used as a mechanism for coping with many different kinds of disaster or shock, whereas conventional DRR projects tend to focus on specific hazards. Organisations that manage credit and savings programmes specifically for the poor – usually referred to as micro-finance institutions (MFIs) – come in many different types, ranging from formal institutions (government, private and non-profit) to semi-formal and informal savings and loan groups. There is a similarly wide variety in loan terms and conditions.

In low-income countries, most financial support in times of need comes from within households and extended families, or by borrowing from neighbours and local money lenders. These sources are easily accessible, but they can only provide relatively small amounts; and in the case of money lenders, they are costly, as interest on repayments is high. Savings and loan groups are common in many parts of the world. They are organised in a variety of ways, with differing degrees of formality, often by community members themselves or with the support of external organisations. They often begin with poor people pooling their savings; some evolve from other types of self-help group, club or association. The rules of individual savings and loan groups vary widely, but the basic principle is that members who pay in regularly are entitled to draw on the group for loans, in turns or according to need, when sufficient funds are available. Well-established groups sometimes attract additional finance from NGOs or other agencies.

A number of NGOs run savings and credit schemes, which often form an important element in their development programmes; some are starting to develop a wider range of financial services for poor people. More formal MFIs tend to operate like conventional credit institutions, lending money at interest over fixed terms. However, they are accessible to the poor because they accept small deposits, charge lower fees to savers and have lower or no collateral requirements.

The principles and rules of savings and credit schemes can be difficult for users to understand. There is a general need for improved financial literacy to increase people’s understanding of the different financial institutions and services available to them. This enables them to make informed choices, but is also important in maintaining trust and ensuring the reliability and continuity of financial services.

MFIs use a variety of methods to help their clients deal with disasters. Rescheduling loans after disasters have struck is a common practice. Writing off loans is undesirable because it undermines clients’ long-term commitment to repay as well as being a loss to the microfinance scheme itself. Many MFIs provide emergency loans to clients to meet immediate needs for food, clean water or medicine (programmes often set a percentage of total savings aside as an emergency fund for loans and grants to clients in crisis). These are made at lower interest rates, or even without interest, although many clients still prefer to borrow informally from friends, relatives and money-lenders. Even where credit programmes are available, informal borrowing remains important in poor communities, especially if the money is to be spent on consumption rather than invested in productive activity (at times of crisis families go to great lengths not to use up their savings or sell off their livelihood assets). They are more likely to take up emergency loans from MFIs if the loans can be made rapidly and come with few or no restrictions on how they can be used and lower or no collateral requirements. Some post-disaster loans are made to replace or repair physical livelihood assets: equipment for income-generating activities, such as cooking utensils or sewing machines, and rebuilding business premises. They tend to be relatively large and are usually made once the relief period is over, at normal interest rates and with a longer repayment period. Only large MFIs can afford to make a large number of asset replacement and housing loans, and there is some evidence of higher than usual failures to repay. For this reason, MFIs often prefer to provide standard short-term working capital loans, seeing these as best suited for disaster recovery.

MFIs need to react quickly in a disaster, in assessing the situation and planning their response. This is not always easy: local branch offices may be damaged or inaccessible, electricity supplies and transport networks disrupted and communications broken down. Disaster victims may be physically unable to withdraw savings, take out new loans or renegotiate old ones. Branch staff need training to manage in such circumstances; crisis management plans should be drawn up, and clear guidance given on lending policy and practice. MFIs should be linked to early warning systems, and ensure that their clients are informed about potential disasters. Client assessment and market research help MFIs to understand how disasters will affect their clients and how to support the revival of small enterprises and local markets. MFIs also often undertake short-term relief work, though this can cause problems for staff who are not trained as aid workers. MFIs engaged in relief need to communicate clearly to their clients that their efforts are temporary and one-off, and do not influence their primary role as providers of finance.

In some countries where disasters are a regular occurrence, it is common practice for MFIs to make savings and credit groups or individual clients pay a percentage of their ‘compulsory savings’ into an emergency fund (compulsory savings are regular deposits made by borrowers to build up collateral against their loans: normally they cannot be withdrawn while loan repayments are still outstanding). Money from the fund can be made available quickly to disaster-affected borrowers in the form of emergency loans. After a disaster, many MFI clients will withdraw these savings, but such rapid, large-scale withdrawals can cause problems for smaller MFIs, especially if they have reinvested compulsory savings in their standard loan programmes. The stricter the conditions attached to the use of compulsory savings in emergencies, the more likely it is that poor people will look elsewhere for other sources of money, including money lenders.

Financial practice is currently geared more towards managing response than promoting DRR, but MFIs can and do introduce preparedness and mitigation initiatives for their clients. This is more likely where the micro-finance programme or institution is part of a larger NGO’s portfolio. For example, MFIs in Bangladesh have made subsidised loans for emergency preparedness purchases such as food, fuel and water purification and rehydration tablets. Housing loans may be provided to help clients build in safer locations. MFIs can encourage their clients to form welfare or disaster insurance funds, or arrange for clients to rent space in seed and grain banks. Some MFIs insist that their members develop their own contingency plans. There is also potential for using non-financial credit – loans of seeds, tools or materials – to help reduce risk.

Case Study 12.3 Community savings schemes and post-disaster recovery

The Homeless People’s Federation Philippines (HPFPI), founded in 1998, is a national network of 200 community associations and savings groups representing over 19,000 households. In 2000, the collapse of a massive rubbish dump in Patayas, Quezon City, killed around 300 people and displaced several hundred families. HPFPI had been working in the community for several years. Members of HPFPI savings groups helped to provide immediate support, and HPFPI negotiated the resettlement of over 500 families to safer locations, establishing a savings scheme that enabled them to rebuild on the new sites and pay ground rents. In 2008, a typhoon hit the city of Iliolo, with more than 50,000 people affected by flooding. In response to the need for financial assistance for relocating and rebuilding its member communities, HPFPI mobilised its Urban Poor Development Fund (UPDF) to procure building materials for affected families. Costs of labour for house reconstruction were shared between the city government and HPFPI.

J. C. Rayos Co, Community-driven Disaster Intervention: Experiences of the Homeless People’s Federation Philippines, Incorporated (HPFPI) (London: International Institute for Environment and Development, 2010), http://pubs.iied.org/10587IIED.html.

One important lesson from large-scale disasters is the need to protect MFIs themselves from failure. Many MFIs do not have sufficient capital to support their existing clients during and after a major crisis; small-scale savings and loan schemes or revolving funds in particular can find themselves critically short of funds if disaster-affected borrowers fail to keep up with repayments. During extensive floods in Bangladesh in 1998, the micro-credit system was put under severe strain: loan recovery rates fell from 92% to 43%, and MFI staff could not locate borrowers or arrange group meetings. Informal savings and loan schemes in Haiti were badly affected by the January 2010 earthquake, with savings trapped under the rubble of collapsed buildings, stolen or simply lost; people responsible for looking after cash had often been killed or had moved away.+Microenterprise Best Practices Project, Loan Rescheduling After a Natural Disaster (Washington DC: Development Alternatives Inc./USAID, 1998), http://www.gdrc.org/icm/disasters/rapid_onset_brief_1.pdf; Feinstein International Center and Interuniversity Institute for Research and Development, Disaster Risk Reduction and Financial Strategies of the Poor: Demand for, Access to, and Impact of Cash in Haiti Following the 2010 Earthquake (Somerville, MA: Feinstein International Center, 2013), http://fic.tufts.edu/assets/TUFTS_1385_Haiti_2_online-UPDATED.pdf. MFIs can spread their risk by making sure that they serve poor clients in areas less likely to be affected by hazards, or by lending to people involved in more than one sector of the economy. For this, they need to undertake their own risk assessments. But even well-prepared MFIs are unlikely to be able to cope with massive disasters. Obtaining new sources of credit takes too long, although the creation of emergency lending facilities for MFIs can speed things up (see Box 12.1: Emergency lending to MFIs).

Box 12.1 Emergency lending to MFIs

The Emergency Liquidity Facility (ELF), launched in 2005, provides loans to Latin American MFIs so that they can respond quickly to disaster-affected clients. It has a loan fund of $12m, financed by the Inter-American Development Bank, the Swiss government and a range of other institutions that support micro-finance. To ensure speedy decision-making in times of crisis, MFIs are preselected for ELF support through an evaluation of their capabilities, structure and financial situation: over 50 MFIs from 13 countries have qualified for the scheme. By 2012 the ELF had disbursed $36m to 37 MFIs in a variety of disasters and emergencies, including the 2010 Haiti earthquake.

http://www.omtrixinc.com/index.php/en/; K. Jacobsen, A. Marshak and M. Griffith, Increasing the Financial Resilience of Disaster-affected Populations, Feinstein International Center, Tufts University, 2009, http://fic.tufts.edu/publication-item/increasing-the-financial-resilience-of-disaster-affected-populations; http://fic.tufts.edu/assets/Increasing-Financial-Resilience-2009.pdf.