The Foundation for Development Cooperation's 'Banking with the Poor' project stresses the importance of linkages between commercial banks on the one hand, and non-government organizations (NGOs) and self-help groups of the poor (SHGs) on the other, as a mechanism for channelling credit to the poor on a sustainable basis. In addition to offering a number of other advantages, such 'linkages' can reduce the transaction costs of lending and borrowing. This article describes two studies, one in India and one in the Philippines, which set out to quantify the transaction costs of commercial banks and NGOs in lending to the poor, and the transaction costs facing poor borrowers. The Indian study compared the transaction costs incurred by banks when lending to the poor through various channels, and found that transaction costs were much lower where banks used NGOs and SHGs as intermediaries. Transaction costs facing borrowers were also significantly lower. This suggests an important role for NGOs in the intermediation process.The Philippines study looked at the question from the perspective of the NGOs. It found that NGOs could channel credit to the poor with lower transaction costs, as a proportion of loans granted, than most other institutions. Nevertheless, the small loans and short maturities inherent in lending to the poor inevitably led to transaction costs being relatively high compared to the value of loans outstanding at any one point in time. This highlights the need for NGOs to minimize costs as far as possible, and the article includes a number of measures that would help them to achieve financial sustainability.
In recent years, a number of countries in Asia have established 'second-tier' or 'wholesale' microfinance institutions to channel funds from the government and/or donor agencies to individual 'retail' microfinance institutions (MFIs) at concessional interest rates. The largest of these is the Palli Karma Sahayak Foundation (PKSF) in Bangladesh, but second-tier institutions are also major players in India, Sri Lanka, the Philippines and Thailand. This article reviews the experience of second-tier microfinance institutions in a number of countries in Asia. It finds that such institutions can be a very effective means for governments and donor agencies to channel support to MFIs. It is more efficient for one institution to monitor and evaluate MFIs than for different governments and donor agencies to conduct their own analyses. Perhaps most importantly, second-tier institutions can also contribute significantly to a more efficient microfinance sector by setting and enforcing appropriate performance and reporting standards.