MFIs and the new frontier of climate-responsive financial products

Microfinance institutions (MFIs) in Bangladesh have made great strides in providing collateral-free smaller loans to the poor, especially poor women. In this country, microfinance has played an important role in reducing financial market imperfections by introducing viable financial products for unserved and underserved populations of the traditional banking sector. It has also provided an opportunity for the rural poor to depend less on irregular earning activities such as farm day labouring by diversifying into non-farm activities.

According to the 2022 Household Income and Expenditure Survey (HIES) of Bangladesh, about 70 per cent of all borrowers took loans from MFIs, suggesting a remarkable contribution of MFIs to financial inclusion in the country. The highest number of borrowers (21 per cent) took out loans from ASA, followed by BRAC (14 per cent) and Grameen Bank (12 per cent).

Data suggest that the dependency on informal moneylenders, who generally charge exorbitant interest rates, has declined in the country as a result of the wide availability of microfinance. HIES data show that about 2.8 per cent of all borrowers took loans from money lenders in 2022, against over 4.4 per cent in 2010. The reported repayment performance of MFI loans is generally very high. According to a report by the Microcredit Regulatory Authority, 90 per cent of MFI loans were paid regularly (good loans) and another 5 per cent, considered as watch loans, were due between 1 to 30 days. Research suggests that Bangladeshi families receiving microfinance have significantly improved their livelihoods. A study shows that if microcredit had not existed, rural poverty in Bangladesh would have been about 5 per cent higher than what it was in 2010.

But can microfinance also play a role in tackling the challenges of climate change? Bangladesh is highly vulnerable to climate change, which is already increasing in intensities and frequencies of cyclones, river erosion, floods, landslides, and droughts in the country. Agriculture, a sector already vulnerable to the unpredictability of weather and a degrading environment, is now facing serious threats from climate change. Farmers have started experiencing its impact-decreasing crop yield, higher pest and disease incidence, and food insecurity.

In the absence of crop insurance, farm households are likely to underinvest in risky but profitable crops or technology, fearing possible loss from increasingly unpredictable weather. Such underinvestment negatively impacts long-term farm growth and profitability. MFIs play an important role in managing the risk in agriculture as many farm households take conventional microcredit. Moreover, some MFIs disburse seasonal loans to farm households. These loans provide farmers with a convenient repayment scheme, often including the provision of a grace period.

However, MFIs should introduce new products to manage agricultural risk better. A recent study published in a reputed journal shows that if a loan product guarantees credit access to farm households following a negative shock, it increases their welfare through increasing investments in risky but profitable production. Households also use the loan to make consumption smoother, i.e., purchasing essentials during lean seasons. The study was done on a new loan product piloted in Bangladesh. The main idea of the product is as follows. Existing microfinance borrowers were informed that they were pre-approved for this loan (called Emergency Loan) before the Aman season, distributing referral slips to eligible clients. Eligible households were approved to borrow up to 50 per cent of the total principal amount of their last regularly approved loan from the MFI, regardless of their existing loan balance at the time of disbursal, in case of a flood before the season is over. For example, an eligible borrower who took a BDT 10,000 loan from the MFI was guaranteed to borrow up to BDT 5,000 should a flood occur. Clients with or without an active loan were eligible for the Emergency Loan. Eligible clients could request an Emergency loan if flooding occurred in the area. MFIs can scale up similar products to address the vulnerability of clients due to floods or other events such as droughts and cyclones.

Research shows that repayment flexibility allows borrowers to invest in riskier and more profitable activities. Research also indicates that repayment flexibility is an attractive feature for borrowers who may underestimate the magnitude of future repayments and default. Further, repayment flexibility increases borrowings significantly. Hence MFIs can also introduce loans that guarantee repayment flexibilities to borrowers/potential borrowers following a negative shock. Like the emergency loans discussed above, repayment flexibility may increase investment in agriculture, thereby increasing farm production and household welfare.

A World Bank study predicts that climate change will push an additional 37.6-100.7 million people into extreme poverty by 2030 worldwide. Hence, it is likely that climate change will increase the number of extreme-poor people in Bangladesh. MFIs should introduce products that better serve the extreme poor, as evidence indicates that conventional microfinance struggles to reach this group. Both demand- and supply-side constraints limit their access to microfinance. Often, traditional microfinance products are not viable for the extreme-poor; conversely, extreme-poor clients fail to benefit from these products. Recognising the challenges, many MFIs implement customised microcredit, a combination of loans and grants, for the extreme poor. Evidence suggests that a package of support consisting of credit, training, and grants in the form of daily allowance given to extreme-poor households increases their productive asset holding by 135 per cent and income by 19 per cent. Such programmes, however, are costly. Hence, the government should support reputed MFIs to implement these programmess to support extreme-poor households simultaneously mitigate climate risks and break out of the poverty trap.

The author is a Professor at BRAC Institute of Governance and Development (BIGD), at BRAC University.

[email protected]