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Differences in Lending Methodologies in Microfinance

Differences in Lending Methodologies in Microfinance

Wed, March 16, 2011


This week I have been reading up on the various lending models used in microfinance and I found the diagram below, depicted in this Russian Microfinance Project report and adapted from the "CARE Savings and Credit Sourcebook," to be very useful for my analysis. According to this report, group lending in microfinance is broken down in two major categories: solidarity groups (Grameen Bank models and models used in Latin America) and community-based organizations (community managed loan funds and village savings and loan associations).

Diagram showing different group lending methodologies.


The solidarity group model became very famous in 1976 after it was applied by Dr. Muhammad Yunus in Grameen Bank. Later on this model was expanded to Latin America but with some adjustments—rather than address various social challenges like Grameen Bank (such as the “Sixteen Decisions” framework), they chose instead to focus more on credit provision. Solidarity group models in Latin America chose to retain loan approval and administration, using the already-existing operational systems developed for individual lending.

Community-based organizations (CBO) differ from solidarity group in that they assume eventual graduation of their borrowers from the lending institutions. Therefore, the primary function of CBOs is to develop internal financial management capacity of the group in order to create a mini-bank, independent of the lending institution, owned and managed entirely by the poor.  The subcategories of the CBOs are community managed loan funds (CMLF) and village savings and loan associations (VSLA). The former is more widely known as a village banking model and it was developed by John Hatch of FINCA. The main distinctions between CMFLs and VSLAs are the following:

  •  CMLFs receive initial external funding (in the form of a loan or grant).  There are two main approaches to community-managed loan funds—Village Banking and Revolving Loan Funds. In addition to the external funding, CMLFs have internal fund (money invested by the members of the fund).
  • VSLAs generate all funds internally (through member savings or retained interest) and receive no external funding. VSLAs can receive technical assistance from NGOs and some equity funding only.

According to David Roodman, self-help groups (SHG) in India can be considered "a cousin of village banking" and "the Indian SHG bank linkage system is the largest 'microfinance' program in the world." SHGs differ from traditional microfinance models because the government became more involved with forming SHGs in India by implementing so called “priority sector lending rules” that penalized banks that devoted less than 40% of their credit to underserved or deserving groups. By 2010, a cumulative 4.6 million SHGs had received bank loans. Therefore, although SHGs are just used in India, they can be considered a separate lending methodology in microfinance. Just as with the CBOs, members of SHGs should strive to be independent from external capital by saving money in the group's fund.

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Comments (1)
Mar 18, 2011   09:48

Some of the disadvantages of group lending can be:

1. Costs of attending meetings and monitoring group members

2. Amount of money granted to the group is capped at what group can guarantee as a whole, which sometimes slows down business growth for the wealther members of the group

3. Borrowers can collude against banks so that banks do not harness "social collateral"

4. Group lending methodology can be costly to implement

As the result, ASA in Bangladesh decided that joint responsibility aspect of group lending was not cost effective but it other aspects, such as public reputation, education provided in group meetings and common participation were beneficial. Therefore, ASA continued group lending methodology by without the joint responsibility aspect.