December 2008 · Number 139 A regular series of notes highlighting recent lessons emerging from the operational and analytical program of the World Bank`s Latin America and Caribbean Region. Microfinance and Disasters Preparing for the Worst 47529 Mike Goldberg and Sunita Varada This note discusses natural disaster preparation and how This chaotic scene has been repeated around the world in MFIs and their staffs can respond. It is part of a series recent years--after earthquakes in El Salvador and Peru, that summarizes a distance learning series with South hurricanes in Nicaragua and Guatemala, floods in Poland American microfinance networks and government of- and Bangladesh, and the tsunami in South and Southeast ficials. Preparation for disaster includes understanding Asia. However, as MFIs in Poland and Bangladesh have the risks and costs of disasters, establishing proactive proven, MFIs can be important partners in preparation approaches and concrete responses, and knowing the for disaster and post-disaster recovery efforts--thanks resources and partnerships that may prove helpful in an to their systems, products and relationships with low in- emergency. come community leaders and microbusinesses. Unfortunately a common story... The Risks and Costs of Disasters Imagine the manager of a microfinance institution (MFI) Disasters can affect a microfinance institution in human, arriving at the main office and finding windows smashed, physical and financial ways. The upheaval can affect the furniture, comput- staff and consultants, borrowers ers and files destroyed and savers, donors and govern- and the security sys- ments that provide financial tem off-line. Even support, and basic service provid- worse, most of the ers (such as transportation and MFI's staff fail to electricity). The costs can be ex- report to work, and traordinarily high. Damages from the police condemn Hurricane Mitch in Nicaragua in the office building as 1998 amounted to about 45 per- structurally unsafe. Is cent of the national GDP. After the manager prepared the short term destruction, the ef- for such a situation? fects linger, as tens of thousands Will the MFI be able are dislocated and in need of new to continue offering its vital services? If it is like most short term or long term housing loans and income-gener- such institutions around the world, it is completely un- ating opportunities and productive assets. prepared for the destruction the manger finds--and the price to be paid will be extraordinarily high, both by the Costs - In addition to the human costs, MFIs also suffer MFI and its clients. immediate financial shocks. The include liquidity ef- The work described in this note was supported by the UK Government's Department of International Development (DFID) through the Markets and Governance for Poverty Reduction Fund (MGPR) Trust Fund. The views expressed in this document are not necessarily those of the UK Department for International Development' fects, repayment issues, and changes in the priorities flexible in the event of a disaster, staff should be pro- of commercial and other funders. Liquidity effects vided a special brief operating manual. This will ensure begin with the risk that the commercial banks holding that all clients receive the same information about what the MFI's checking and savings accounts may suffer assistance and adjustments are available. physical damage to facilities, or may be overwhelmed by liquidity requirements. Borrowers may contribute to Contingency Funds the MFI's liquidity problems by failing to pay on time. The direct response to liquidity problems is a dedicated Since microbusiness operators rarely have insurance contingency fund. Periodically, based on a strategic coverage for income, assets and health care needs, they target, the MFIs in disaster-prone areas should add to a may turn to the MFI for new loans or to reschedule special disaster recovery reserve fund. This earmarked or refinance existing loans. This puts pressure on the fund can be used for disaster relief in the form of short MFI's ability to maintain adequate liquidity reserves. term loans to clients, or as a recovery fund for the MFI Also, repayment issues arise after a disaster. Donors (to repair or replace key equipment and infrastructure). may change priorities, leaving MFIs without sources of Contingency funds can be an advantageous solution for funds. the clients, the MFI, the Government and the donors: · Clients can re-establish income streams quickly, get- Proactive Approaches and Concrete Responses ting funds for medicines, food and temporary housing The opportunities and challenges for the MFI will costs. change as the disaster cycle moves from relief to re- · The MFI can reduce the risks of delinquent clients habilitation and long term recovery, especially in (i) and loan loss reserves can be reduced. pre-disaster planning and (ii) restoration of sustainable · The government can focus on the logistics of rescue, livelihoods. emergency housing, and relocation. · Donors often contribute to the initial capitalization of Pre-disaster Planning. Before disaster strikes, the such funds, since experience shows that administra- MFI's management should develop a contingency tive costs are lower and response time decreases when plan. Given the losses that could result from the lack contingency funds are in place. of preparation, the MFI Board may also wish to review the There are three types of contin- plan and provide input. The gency funds. The first is assigned MFI's contingency plan should to a single MFI, usually a large deal with communications one with many years of experi- between branches and head- ence, efficient administrative quarters staff, clarifying the systems, and nationwide cover- changes in internal policies age. The second is operated by a and backup communications special administrative unit. The systems to be used in the af- third is a contingency fund that is termath of a disaster. Critical shared by various MFIs: each one information should be protected--with electronic back- responsible for regional coverage or specific communities. ups of records maintained on a regular basis in a secure location outside the MFI's offices--if the MFI Board Are disaster contingency funds appropriate for all considers this to be prudent. MFIs? The most successful funds have been estab- lished in disaster-prone areas, such as South Asia (with Communication with clients is also important, so that annual flooding caused by monsoons). Larger MFIs are there are clear expectations of what support may be also more likely to benefit from disaster contingency available in the aftermath of a disaster. The MFI can funds, since they are in a better position to contribute ensure adequate pre-disaster communication by dis- the necessary reserves. There is a debate in the litera- cussing disaster policies and practices at orientation of ture about whether such funds should be sustainable, new clients, and reviewing the policies when clients once they are established with reserves. If the MFI can apply for subsequent loans. If management decides that link to an existing contingency fund, then such reserves lending and collection policies are going to be more can be maintained at a minimum. (For information on 2 · December 2008 · Number 139 the Bank's Catastrophe Risk Deferred Drawdown Option (CAT DDO), see the Bank's website.) Box 1: Loan Product Adjustments for Disasters: The Bangladesh Rural Advancement Committee (BRAC) Restoration of Livelihoods. The MFI should have poli- cies in place concerning the types of loans to be pro- Given the monsoon season, and the country's huge delta vided on a temporary basis-- consumer loans, housing basin, floods are a regular threat to the productive assets of repair loans, and working capital loans. Extended grace Bangladesh's micro businesses. In response, several MFIs periods can help microbusinesses get back on their feet have come up with financial products that address this risk. more quickly. The MFI may use previous loan repay- Specific adjustments in loan policies and credit characteris- ment performance as one of the ways to prioritize which tics include: business operators receive the special business recovery · Clients can withdraw savings up to a specific pre-estab- loans. Communities may be asked to back a recovery lished amount. loan with a character reference. · Regular loan repayments can be suspended for a period. · Interest rates can be reduced significantly for up to two Branch offices should be trained in how to respond to months. requests for emergency loans by clients and others in · Loans can be restructured for clients with marginal di- affected areas. Management should establish specific saster losses (based on field visits). · Loans can be refinanced for clients with high disaster lending limits for clients, new selection criteria, and losses (based on field visits). possibly adjustments to collateral and other normal re- · New loans for productive asset replacement of up to 12 quirements. Whatever the decision, management should months, at 15 percent interest. provide the disaster relief guidelines in internal written · Option of disbursement in the form of seeds, animals, communications, in case branch office staff members and other in-kind materials. are unable to get in touch with the headquarters office. When branch managers know what levels of lending au- Source: Pantoja, World Bank, 2008 thority and special loan conditions apply, they are bet- ter prepared to act independently to respond to clients' needs during an emergency. BRAC provides a good sisted by local municipalities. Since this was a one-time example of the kinds of quick adjustments that can be contingency fund approach, there was no capitalization made to help clients (Box 1). of the fund. The 1997 floods in Poland provide an innovative example By the end of the six-month emergency period, Fun- of disaster management by an MFI. Floods severely af- dusz Mikro had not only responded to the unique set of fected 1,400 small towns, destroying 50,000 homes, forc- circumstances, it had identified a significant number of ing the relocation of 160,000 people, and causing damage new clients for a long term commercial relationship. By worth US$4 billion. Given its national coverage, the MFI setting a time limit on the emergency loan product, Fun- Fundusz Mikro was asked to manage a special disaster dusz Mikro maintained credit discipline, while building recovery fund. Fundusz Mikro opened a special lending a reputation as a socially responsible MFI. With on-time window within its branches, developing a new brand for repayment of 93 percent, Fundusz Mikro was able to the emergency situation. This loan product had a different demonstrate that, even under difficult conditions, its cli- contract format and lending terms (24 month loan term, ent selection methodology was sound. 10 percent near-commercial interest rate, and a six month grace period). A special window was established for pro- As the Polish and Bangladeshi examples illustrate, cessing loan applications. MFIs can adjust or launch products to address specific disaster-related impacts. These new products can Existing and new clients formed solidarity groups of five build client loyalty and minimize the response time members, evaluated the damage and submitted loan ap- to client requests. Such products include emergency plications. The solidarity group was responsible for as- loans, housing loans, cereal banks, remittance servic- signing priorities to members with urgent needs. Fundusz es, and subsistence loans (see Table 1). Mikro disbursed the loan, monitored business perfor- mance, and collected the payment. Loan recovery was as- December 2008 · Number 139 · 3 Table 1: New Products with implications for Disaster in-kind, in the form of boats and some working capital. Response Time and Effectiveness Since most borrowers do not have sufficient guarantees, Financial Results Implications the boats will also serve as a form of loan collateral. Product The project capitalizes a revolving fund and the inter- est rate policy is structured to maintain long term fund Emergency Increased client Effective only sustainability while still helping the fishermen during the loans loyalty. during relief emergency phase. A six-month grace period is followed stages; partial by a phase where they will charge 5 percent interest and safely net for thereafter, the interest rate will be adjusted to account for existing clients. inflation and all administrative and supervision costs. Housing Moderate Effective only loans repayment. Timely when issued Conclusion loans based on quickly and based demand and on demand. MFIs have a unique combination of skills, networks, and flexible terms client bases that make them valuable partners during a Only for housing disaster. By coordinating with other MFIs, government repair agencies, municipal authorities and donors, the MFI is in the best position to be a strong partner in local and Cereal Used for Effective only dur- even national responses. With plans in place for the banks smoothing ing relief stage for most likely human, physical and financial shocks in the consumption mild droughts aftermath of a hurricane, earthquake or flood, the MFI during droughts; can serve the immediate needs of its clients. Some effec- Remittance Eases cash-flow Required tive responses to disasters have included new types of Services problems of clients immediately after loan products, adjustments to conditions for outstanding Increases client disaster and based loans, and changes in delivery methodologies (such as al- loyalty on demand lowing groups to set lending priorities among members). Whatever the response, MFIs should learn from the pain- Source: Adapted from Nagarajan, 1998. ful lessons of the past--because the benefits of preparing for the next disaster far outweigh the costs. Restoring Livelihoods: An Example from Nicaragua A recent Bank project in Nicaragua shows how a disaster Bibliography response can build more sustainable livelihoods. In Sep- Goldberg, Michael. Presentation to Distance Learning tember 2007, Hurricane Felix hit the North Atlantic Au- Session #8, "Cómo se puede proteger clientes e IMFs tonomous Region (RAAN) of Nicaragua. About 200,000 después de desastres?" World Bank, February 13, 2008. people were directly affected by the disaster, and there was extensive damage to infrastructure and important Nagarajan, Geetha, Microfinance in the Wake of Natural productive sectors (agriculture and fisheries). Disasters: Challenges and Opportunities. Microenterprise Best Practices. World Bank, March 1998. The Government and the Bank launched an Emergency Recovery Project, including work to restore the liveli- Pantoja, Enrique. Presentation to Distance Learning Ses- hoods of small-scale fishermen and women. This sector sion #8, "Microfinanzas y la Gestión del Riesgo a Desas- already suffered from low productivity, basic technology, tres Naturales". World Bank, February 13, 2008. and poor infrastructure. The region was also character- ized by poor access to finance, due to the region's high- risk climate and unattractive borrower characteristics About the Authors (small loans, limited available collateral). Mike Goldberg is a Senior Private Sector Specialist and Sunita Varada is a Consultant, both with the Poverty The government's Rural Credit Fund (FCR) will admin- Reduction and Economic Management Department of the ister the loans to groups of fishermen. The loans will be Latin America and the Caribbean Region of the World Bank. "en breve" is produced by the Knowledge and Learning Team of the Operations Services Department of the Latin America and the Caribbean Region of the World Bank - http://www.worldbank.org/lac · December 2008 · Number 139