«UNITED NATIONS INDUSTRIAL DEVELOPMENT ORGANIZATION economy environment employment SME TECHNICAL WORKING PAPERS SERIES Working Paper No. 14 Combining ...»
Both microfinance providers and UNIDO aim to reduce poverty by assisting the poor in creating and expanding their enterprises. Whereas microfinance providers address financial constraints, UNIDO seeks to improve business performance by fostering interfirm cooperation and providing linkages to support agencies. A partnership between UNIDO’s CDP and microfinance providers, in which each organisation focuses on its comparative advantage and expertise, can promote the provision of sustainable and profitable financial services to the economically active poor and contribute to pro-poor cluster development.
Although the use of self-help groups as financial intermediaries reduces the costs of providing credit and savings facilities, microfinance providers must nevertheless reach a minimum scale to reach profitability. Cooperation with the CDP facilitates reaching this minimum scale. Through its projects, the CDP has gained experience in creating and strengthening networks. It thus has the expertise to build the institutional capacity of selfhelp groups needed for financial intermediation. Banks cooperating with the CDP can therefore access strong SHGs with viable business propositions while avoiding the high up-front costs of group formation.
Microfinance provision by itself is often insufficient to improve business performance since clients need information, skills, adequate technology as well as backward and forward linkages to be able to use the financial resources obtained effectively. To maximise the benefits of financial service provision, many microfinance providers therefore attempt to provide support services to their clients. However, experience has shown that this often exceeds the capacity and resources of these institutions. The result is the provision of suboptimal services and/or exessive costs which cannot be recovered through normal credit operations. Sustainability and outreach of microfinance provision is therefore jeopardized. As part of its regular cluster development activities, UNIDO links cluster actors with business development services (BDS) providers and other support institutions, which provide marketing assistance, business management training and technology development support. The linkages created by the Cluster Programme enhance the technological capacity of cluster actors, their ability to innovate, the quality and value of their products and their capacity to respond to changing market conditions. This in turn improves enterprise performance and increases the probability of productive use of a loan as well as borrowers’ repayment capacity. Cooperation between cluster development projects and microfinance providers thus allows each organisation to focus on its respective strengths while offering a comprehensive package to promote enterprise and cluster development.
Many economically active poor work in low-return activities and microcredit is often used to simply expand activities rather than to invest in technological upgrading, to improve productivity or to enter higher value markets. This eventually leads to market saturation ©United Nations Industrial Development Organization
SYNERGIES BETWEEN CLUSTER DEVELOPMENT AND MICROFINANCE 35(Dawson & Jeans, 1997). Bankers may therefore fear that SHG members are unable to sell the goods their loans enabled them to make and may thus have problems in repaying their loans. In clusters supported by the CDP, however, this concern is likely to be irrelevant.
The CDP aims at improving product quality, meeting training needs and creating market linkages. This makes the cluster as a whole more competitive and secures viable business opportunities for SHGs receiving credit. The risk for bankers is therefore minimised.
In sum, clusters can facilitate access to new clients for microfinance providers. For banks and specialised microfinance institutions, clusters promoted by the CDP represent a concentration of potential clients with concrete needs for financial services to fund their viable business activities. By operating in a cluster that has been suitably dynamised, microfinance providers can therefore significantly reduce the costs involved in reaching a new and profitable clientele.
For UNIDO’s CDP, cooperating with microfinance institutions is a strategy to ensure that cluster actors are no longer constrained from realising their viable business propositions by lack of finance and that efforts to stimulate cluster development will have a pro-poor bias23. By integrating microfinance into cluster development activities, the impact on the “bottom of the pyramid” can be enhanced. Access to financial services enables producers in artisan and agro-processing clusters to improve the quality of their products, to ensure regular supply and possibly to reduce prices through improvements in production technology and productivity. This in turn benefits local consumers who will be able to obtain better quality products at a lower price.
With time, integration of microfinance into cluster development activities can have benefits beyond the development of individual enterprises and can profit the cluster as a whole. Experience from Sindhudurg has shown that SHG members already use microfinance for common production. As trust between SHGs and microfinance providers as well as among individual group members grows stronger, there may even be scope for using microfinance to fund joint investments, such as the common purchase of equipment.
Finally, microfinance may also be instrumental in addressing cluster-wide problems such as the need for infrastructure, which is frequently a constraint for the competitiveness of rural clusters in particular. Whereas the CDP’s efforts to link cluster stakeholders with regional and local government institutions have, for example, contributed to improving roads, some infrastructure problems, in particular lack of a reliable supply of electricity, continue to exist. Such issues could possibly be addressed by SHG members with linkages to microfinance providers, e.g. through the joint purchase of power generators - provided, however, that a significant level of trust exists among members.
D. Role of the CDA A distinguishing feature of the UNIDO approach to cluster development is its reliance on a cluster development agent (CDA) - also referred to as broker, cluster change agent, intermediary agent or system integrator by other institutions - whose task is to facilitate implementation of the cluster development initiatives. The CDA, who should be This can be achieved without reverting back to large, inefficient organisations attempting to deliver a wide range of services simultaneously, as was the case in the 1970s (Dawson & Jeans, 1997).
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36 SME TECHNICAL WORKING PAPERS SERIESspecifically trained in the fields of enterprise and cluster diagnostics, conflict management and resolution, network building, project management and project evaluation, operates on a full-time basis within the cluster and enjoys a good degree of autonomy in providing the technical, financial and human resources required for the development of the cluster.
The cluster development agent (CDA) can play a crucial role in improving cluster actors’ access to financial services. In view of the discussion above and keeping in mind the objective of this paper, namely to enhance the synergy between microfinance and cluster development, the remainder of the chapter describes the steps for the CDA to follow in order to create linkages between the SHGs with which s/he works and local financial institutions24. Many of these will need to be addressed simultaneously25.
i) Exploring the Financial Needs of Cluster Actors The sector in which enterprises are active is a crucial determinant of the financial products and services required. The financial needs of cluster actors are likely to differ considerably between industrial clusters (i.e. the clusters which have traditionally been the focus of the Cluster Development Programme) and artisan and agro-processing clusters (i.e. the clusters which are now at the centre of the action research determining the impact of cluster development on poverty reduction). In these latter clusters, credit needs will be lower. This is partly due to the nature of the economic activity that is less capital-intensive, and partly due to the lower debt-servicing capacity of the economically active poor who represent an important group of cluster actors in artisan and agro-processing clusters. Since microenterprises in artisanal and agro-processing clusters tend to be home-based and are an integral part of households’ livelihoods strategies, it will not always be possible to make a clear distinction between the financial services required by households and those required by microenterprises. This is not the case in industrial clusters.
In addition to variations across clusters, there are differences in financial needs among diverse cluster actors within a cluster. The financial services demanded will not be the same for individuals engaged in income-generating activities, microenterprises and small and medium enterprises. Within these categories, there will again be differences between start-ups and existing enterprises. The financial needs of growing micro and small enterprises and of non-poor cluster actors will briefly be discussed in section (vii) below.
A genuine demand for financial services must be ascertained but also that access to credit will positively impact on poor cluster actors. Frequently, lower input costs or access to markets for existing products are seen as more important than access to credit. Even when cluster actors perceive a need for credit, their true problems may lie elsewhere, e.g. in a lack of skills, quality products or market information. Providing credit in these cases could What follows represents a first step in uncovering the potential synergy between cluster development and microfinance. In principles, there might be broader and more ambitious agenda such as, for example, microfinance institutions becoming providers of funding for cluster development initiatives. Such discussion appears premature at this stage, when the actual scope for operational rather than strategic synergy is yet to be ascertained.
The steps involved in forming and strengthening SHGs are not described. Interested readers may refer to NABARD’s Handbook on Forming Self-Help Groups, available at http://www.nabard.org/roles/mcid/formingshgs.pdf.
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SYNERGIES BETWEEN CLUSTER DEVELOPMENT AND MICROFINANCE 37be counterproductive. To identify truly unserved or underserved cluster actors, it needs to be determined which financial services are currently being provided and to establish whether poor cluster actors are resorting to informal financial sources.
It should also be identified at what point in time poor cluster actors will benefit most from access to financial services. Trust only evolves slowly within SHGs and they need to be given sufficient time for bank linkage. If credit is available too early, e.g. before groups are prepared for the non-financial aspects of credit taking such as the capacity to use peer pressure, the ability of groups to ensure repayment - and thus to access financial services in the future - can be compromised. If credit is provided too late, however, enterprise performance can critically be harmed. The timing of credit delivery is thus crucial.
ii) Identifying Suitable Partner Institutions After the financial needs of cluster actors have been determined and if it has been found that there is demand for microfinance, potential partner institutions must be identified. It therefore needs to be established which local institutions are able and willing to provide microfinance to poor cluster actors. In India, a variety of public and private sector institutions provide microfinance. These include commercial banks, regional rural banks, cooperative banks, non-banking financial companies (NBFCs), NGOs, cooperative societies and SHG Federations. It is estimated that about 800 microfinance institutions which are not part of the formal banking system exist in India. However, only ten of them reach more than 100,000 clients and most are concentrated in southern India. With the exception of NBFCs, private microfinance institutions in India are still unregulated and are evolving (NABARD, 2004). Development financial institutions such as NABARD and SIDBI support Indian microfinance providers for on-lending and capacity building.
For cluster actors, permanent access to financial services is crucial. Since cluster actors must be able to rely on the established linkages to financial institutions also once UNIDO has withdrawn, the partner institutions chosen must be well-placed to provide microfinance services in a sustainable manner. They must therefore be financially sound and have adapted their credit and savings methodologies to low-income clients. Although there is no one right microfinance model, some good practices can be identified regarding the provision of microcredit and microsavings as well as concerning administrative issues.
Box 3.2 summarises basic good practices in microfinance provision, which may assist in identifying a suitable partner institution.
It is neither necessary nor desirable to focus solely on one partner institution. The larger the number of financial institutions able and willing to work with SHGs, the greater the options of financial services for groups to choose from. In Sindhudurg, for example, the CDP works with a cooperative society as well as a variety of banks, including Sindhudurg District Central Cooperative Bank, Ratnagiri Sindhudurg Gramin Bank, Bank of India, ICICI Bank, NABARD and SIDBI.
Box 3.2 Good Practices in Microfinance Provision
• No stringent requirements on loan use. Although investment in productive uses will increase income and thus the likelihood of repayment, clients will typically need to meet consumption needs before money can be invested productively.
• Rapid disbursement of loans. Delays in obtaining credit can have detrimental effects on the economically active poor. Credit should thus be disbursed within one week for new borrowers and within a few days for repeat borrowers.
• Flexible collateral requirements. Peer pressure, group guarantees and/or savings substitute for conventional collateral.