Microenterprise Development: USAID's Program Has Met Some Goals; 
Annual Reporting Has Limitations (17-NOV-03, GAO-04-171).	 
                                                                 
Microenterprises--small businesses owned and operated by poor	 
entrepreneurs--have potential to help the world's poorer	 
populations. For this reason, the U.S. Agency for International  
Development (USAID) included microenterprise development in its  
programming. In 2001, the agency reported that its was conducting
microenterprise projects in 52 countries and had obligated almost
$2 billion since 1988 to support its program. The program	 
supports micro loans, among other services, to assist poor	 
entrepreneurs. Since 1996, USAID has annually reported the	 
program's results. To help Congress oversee USAID's management of
its microenterprise development program, GAO was asked to (1)	 
determine the extent to which the agency's microfinance 	 
activities are meeting the program's key objectives, (2) assess  
the reliability of USAID's reporting on its overall		 
microenterprise activities, and (3) examine the agency's role in 
identifying and disseminating microenterprise best practices.	 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-04-171 					        
    ACCNO:   A08874						        
  TITLE:     Microenterprise Development: USAID's Program Has Met Some
Goals; Annual Reporting Has Limitations 			 
     DATE:   11/17/2003 
  SUBJECT:   Agency reports					 
	     Best practices					 
	     Data integrity					 
	     Economic development				 
	     Foreign economic assistance			 
	     Performance measures				 
	     Small business assistance				 
	     Women						 
	     USAID Microenterprise Results Reporting		 
	     System						 
                                                                 

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GAO-04-171

United States General Accounting Office

GAO Report to the Chairman, Committee on International Relations, House of
                                Representatives

November 2003

MICROENTERPRISE DEVELOPMENT

      USAID's Program Has Met Some Goals; Annual Reporting Has Limitations

GAO-04-171

Highlights of GAO-04-171, a report to the Chairman, House Committee on
International Relations

Microenterprises-small businesses owned and operated by poor
entrepreneurs-have potential to help the world's poorer populations. For
this reason, the U.S. Agency for International Development (USAID)
included microenterprise development in its programming. In 2001, the
agency reported that its was conducting microenterprise projects in 52
countries and had obligated almost $2 billion since 1988 to support its
program. The program supports micro loans, among other services, to assist
poor entrepreneurs. Since 1996, USAID has annually reported the program's
results.

To help Congress oversee USAID's management of its microenterprise
development program, GAO was asked to (1) determine the extent to which
the agency's microfinance activities are meeting the program's key
objectives, (2) assess the reliability of USAID's reporting on its overall
microenterprise activities, and (3) examine the agency's role in
identifying and disseminating microenterprise best practices.

GAO recommends that the Administrator of USAID review the agency's MRR
system to ensure that (1) it measures the program's performance and (2)
all data are collected, analyzed, and reported USAID completely and
accurately. USAID concurred with our recommendation.

www.gao.gov/cgi-bin/getrpt?GAO-04-171.

To view the full product, including the scope and methodology, click on
the link above. For more information, contact David Gootnick at (202)
512-3149 or [email protected].

November 2003

MICROENTERPRISE DEVELOPMENT

USAID's Program Has Met Some Goals; Annual Reporting Has Limitations

USAID's microfinance activities have met some, but not all, of the
agency's microenterprise program objectives. These objectives are to (1)
reduce poverty among participants; (2) target the poor and very poor; (3)
encourage women's participation; and (4) develop sustainable microfinance
institutions (MFI). First, regarding reducing poverty-defined as
alleviating its impacts or lifting and keeping a large number of people
above the poverty line-GAO found that microfinance can help alleviate some
impacts of poverty, incrementally improving borrowers' income levels and
quality of life and offering an important coping mechanism to poor workers
and their families. However, there is little evidence that it can lift and
keep many over the poverty line. Second, microfinance generally has served
the poor clustered around the poverty line but not the very poor. Third,
USAID has successfully encouraged the participation of women, who have
comprised about two-thirds of micro loan clients since 1997. Fourth, USAID
has emphasized the importance of MFI sustainability. In fiscal 2001, of
294 USAID-supported MFIs that reported on sustainability, 38 percent
reported achieving full sustainability-a percentage consistent since 1999.

The basic data in USAID's Microenterprise Results Reporting (MRR) system
are reliable, but certain methodological problems may affect the accuracy
of some of the agency's reporting on key program objectives. Specifically,
USAID may not be reporting accurately (1) the amounts it has obligated to
microenterprise activities; (2) whether 50 percent of its resources went
to the very poor, as required by Congress; and (3) the sustainability of
USAID-supported institutions. Further, although the agency reports
annually on the activities of institutions it supports, it does not show
the percentage of those institutions' total funding that its contribution
represents.

USAID has identified and disseminated microenterprise best practices,
providing information to its missions and implementing partners through
policy guidance, training, and technical assistance. In addition, USAID
has collaborated with microenterprise development provider networks and
others to publish information about these practices.

Microentrepreneur from a USAID-Supported Project in Egypt

Contents

  Letter

Results in Brief
Background
USAID Has Met Some Program Objectives
MRR Data Generally Reliable but May Not Accurately Reflect

USAID's Microenterprise Activities
USAID Has Identified and Disseminated Best Practices
Conclusion
Recommendation to USAID
Agency Comments and Our Evaluation

1

                                                                       2 4 10

26 30 33 33 33

Appendix I Scope and Methodology

Appendix II Microenterprise Best Practices

Appendix III Review of Microenterprise Studies

Appendix IV USAID's Microenterprise Results Reporting

Appendix V 	Comments from the U.S. Agency for International
Development 54

GAO Comments 65

  Appendix VI GAO Contact and Staff Acknowledgements 69

GAO Contact 69
Staff Acknowledgements 69

  Tables

Table 1: Findings and Recommendations from 22 Selected Studies
on Microfinance and Microenterprise Development 44

  Figures

Figure 1: USAID's Microenterprise Development Program, Highlighting
Microfinance Activities 7 Figure 2: Conceptual Diagram of Populations
along the Poverty

Scale 9 Figure 3: Microentrepreneurs in Bulgaria 11 Figure 4:
Microentrepreneurs with Loans from Various USAID

funded MFIs 13 Figure 5: Financial Sustainability of Institutions, by
Average Loan Size 18 Figure 6: Clients in USAID-funded Micro Loan
Projects, by Gender,

1997-2001 19 Figure 7: Women Entrepreneurs at USAID-funded MFIs in Peru 21
Figure 8: Financial Sustainability of MFIs, by Average Number of

Borrowers 24 Figure 9: Available USAID Obligations Data for Poverty
Lending, Fiscal Years 2000 and 2001 28

Abbreviations

ACCION Americans for Community Cooperation in Other Nations
AIMS Assessing the Impact of Microenterprise Services
BDS Business Development Services
CGAP Consultative Group to Assist the Poor
CRS Catholic Relief Services
GAO U.S. General Accounting Office
GEMINI Growth and Equity through Microenterprise Investments

and Institutions MFI microfinance institution MRR Microenterprise Results
Reporting NGO nongovernmental organization SEEP Small Enterprise Education
and Promotion Network USAID U.S. Agency for International Development

This is a work of the U.S. government and is not subject to copyright
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separately.

United States General Accounting Office Washington, DC 20548

November 17, 2003

The Honorable Henry Hyde
Chairman
Committee on International Relations
House of Representatives

Dear Mr. Chairman:

Microenterprises-small businesses owned and operated by poor
entrepreneurs-have potential to help the least advantaged populations in
the developing world. Recognizing this potential, the U.S. Agency for
International Development (USAID) has included microenterprise
development in the agency's strategy for economic development and
poverty reduction. In 2001, the agency reported that it was conducting
microenterprise projects in 52 countries and had obligated almost $2
billion since 1988 to support its program. The Microenterprise for
Self-Reliance and International Anti-Corruption Act of 2000,1 enacted on
October 17, 2000, expressed strong congressional support for
microenterprise projects, stated policy preferences for implementing such
projects, and authorized increased funding.

The key objectives of USAID's microenterprise development program are
to reduce poverty among microenterprise owners, workers, and families; 2
target the poor and the very poor;3 encourage participation by women; and

1Title I of P.L. 106-309. In legislation enacted on June 17, 2003,
Congress amended the act to increase assistance for the poor and provide
changes in how assistance is targeted to the very poor (P.L. 108-31).

2USAID has not defined "poverty reduction." For this report, we applied
the definitions found in a 2002 USAID-funded report on microenterprise
that defined poverty reduction in two ways: (1) alleviating the impacts of
poverty (which can include raising income to permit increased expenditures
on necessities such as food, education, and housing); and (2) lifting and
keeping a large number of people above a nation's poverty line.

3The act defines the very poor as "those living in the bottom 50 percent
below the poverty line as established by the national government of the
country." The act requires that 50 percent of all microenterprise
resources be targeted to the very poor.

develop sustainable microfinance institutions (MFI).4 The majority of
USAID's microenterprise funding supports microfinance services,
particularly micro loans. Since 1996, USAID has annually surveyed missions
and implementing institutions regarding their microenterprise activities
and issued a report to Congress. To assist your committee in overseeing
the agency's management of its microenterprise development program, you
asked that we (1) determine the extent to which USAID's microfinance
activities are meeting the program's key objectives, (2) assess the
reliability of the agency's reporting on its overall microenterprise
activities, and (3) examine the agency's role in identifying and
disseminating microenterprise best practices.

To identify key program objectives, we reviewed USAID's policy guidance
and the Microenterprise for Self-Reliance and International
Anti-Corruption Act of 2000. To determine whether USAID is meeting these
objectives, we interviewed officials from USAID, USAID's implementing
partners, and experts; conducted fieldwork in Peru, Egypt, and Bulgaria,
three countries with established USAID microenterprise programs; and
reviewed academic and applied studies of microenterprise projects and
outcomes. Because most available USAID data and research literature are
focused on microfinance, particularly on micro loans, we primarily
analyzed this aspect of the agency's microenterprise program. To assess
USAID's microenterprise reporting, we evaluated the efforts of the
contractor responsible for the reporting, analyzed the electronic files
containing program data, and checked the reliability of data in the
contractor's system and in the countries we visited. To determine USAID's
role in identifying and disseminating information on best practices, we
reviewed a wide body of literature on the subject; interviewed USAID
officials, implementing partners, and a panel of experts; and reviewed
relevant documents in Washington, D.C., and the countries where we
conducted fieldwork. (See app. I for a discussion of our methodology.)

Results in Brief 	USAID's microfinance activities have met some, but not
all, of the program's key objectives. First, regarding the reduction of
poverty, microfinance can help alleviate some impacts of poverty,
incrementally improving borrowers' income levels and quality of life and
providing poor

4MFIs supply micro loans, savings, and other financial services. To be
considered fully sustainable, the MFI must generate sufficient revenues to
cover both its operational costs (e.g., salaries) and its financial costs
(e.g., the cost of borrowing funds from commercial sources).

individuals, workers, and their families with an important coping
mechanism. However, there is little evidence in the research literature or
consensus among experts that microfinance alone can lift and keep large
numbers of people above the poverty line. Second, although USAIDfunded
studies and academic analyses have found that microfinance activities
generally serve the poor clustered around the poverty line, few loans
appear to be reaching the very poor. At the same time, some research
suggests that loans to the very poor may be ineffective, creating
unmanageable debt, unless combined with other services. Third, the program
has encouraged women's participation in microfinance projects: Women have
comprised two-thirds or more of the micro loan clients in USAID-funded
microfinance projects since 1997, according to USAID data. Finally, the
agency has emphasized the importance of developing fully sustainable MFIs,
and some of the MFIs it funds report having made progress toward this
goal.

Most of the program data in USAID's Microenterprise Results Reporting
(MRR) system were generally reliable, but certain methodological problems
may prevent the agency from accurately reporting its progress in meeting
key objectives. Because of the way the MRR obligations data are collected,
USAID cannot report microenterprise funding levels with certainty. In
addition, its method of estimating the percentage of loans to the very
poor prevents the agency from stating with certainty that it has met the
requirement that 50 percent of its microenterprise resources go to the
very poor. Finally, because differing definitions are used to calculate
sustainability, the sustainability data that USAID-supported MFIs provide
may not be reliable. Moreover, although the agency's annual reports
describe the overall activities of institutions that receive USAID
support, the reports do not provide sufficient data on USAID's
contribution to MFIs and other service providers.

USAID has identified and disseminated best practices for microenterprise
development. The agency has funded initiatives to identify best practices
and has provided information on these practices to its missions and
implementing partners through policy guidance, training, and technical
assistance. USAID also has collaborated with networks of microenterprise
implementing partners and other organizations to publish information on
best practices. (App. II contains a list of key best practices.)

We are recommending that the Administrator of USAID review the agency's
MRR system with the goal of ensuring that its annual reporting is complete
and accurate. Specifically, the Administrator should review and reconsider
the methodologies used for the collection, analysis, and

reporting of data on annual spending targets, outreach to the very poor,
MFI sustainability, and the contribution of USAID's funding to the
institutions it supports.

USAID provided written comments on a draft of this report (see app. V for
the agency's comments and our detailed response). USAID concurred with our
recommendation that it make improvements in its microenterprise reporting,
but it took issue with three points: (1) USAID stated that its
microfinance efforts have reached the very poor, as statutorily defined,
based on the number of micro loans made by institutions that it supports.
This report recognizes that loan size is considered by USAID and the
microenterprise industry as an inadequate indicator of whether micro loans
are reaching the very poor, and Congress has directed the agency to
develop more precise poverty measurement tools. Our report reflects
current research and consensus on the extent to which the very poor are
being served by the program; (2) USAID also stated that it uses a single
definition of sustainability and that the sustainability data reported in
the MRR are reliable. However, we documented differing definitions and
interpretations that affect the reliability of reported sustainability
data; and (3) USAID stated that it would be difficult to allocate the
microenterprise accomplishments reported in the MRR between USAID and
other donors, but it agreed to make other improvements to the MRR,
including providing more explicit instructions on activities to include in
reporting and taking other steps to improve data accuracy. If USAID
implements these improvements, which we believe are responsive to our
recommendation, it could help improve the reliability of the information
in the MRR.

Microenterprise development and its primary component, microfinance,
emerged in the 1980s. Microfinance-the supply of micro loans,5 savings,
and other financial services to the poor-has operated on the premise that
the poor will invest loans in microenterprises, repaying the loans out of
profits, and the enterprises will grow, potentially lifting large numbers
of people out of poverty. Microfinance practitioners have demonstrated
that the poor will repay loans on time and that, despite high transaction
costs, micro loans can support financially viable lending institutions.
Through

5Micro loans-small loans with frequent repayment schedules and commercial
interest rates-are administered by a range of institutions, including
nongovernmental organizations and private financial institutions.

  Background

the 1990s, a wide variety of institutions operating in many countries have
used this model, adapting it to local conditions.

By USAID's definition, a microenterprise consists of a poor owneroperator
and nine or fewer workers. Microentrepreneurs-typically small shopkeepers,
craftspeople, and vendors-face a range of impediments to improving their
standard of living. Most rarely have sufficient collateral to meet loan
requirements at traditional banks; according to one report, only 2.5
percent of potential microenterprise operators have access to financial
services other than moneylenders.6

USAID's microenterprise development program focuses on three key areas:

o  	helping establish and fund MFIs to provide loans and other financial
services to the poor and very poor,

o  	funding business development services (BDS) to help improve the
business skills of microentrepreneurs and develop markets for
microenterprises, and

o  	advocating for host government policy reforms to enhance
microenterprise development.

USAID has been the leading bilateral donor of funds and technical
assistance to microenterprise development projects since 1988, when it
began formally tracking funding. USAID provides funding through
nongovernmental organizations, contractors, and, occasionally, government
organizations that implement the client-level activities. USAID reported
that it committed $158.7 million to microenterprise development activities
in fiscal year 2001, compared with $164.3 million in fiscal year 2000.
Almost two-thirds of USAID's microenterprise development obligations in
fiscal year 2001 were directed to providing financial services,
principally for creating and strengthening existing credit and savings
institutions; the other third went to BDS and policy activities. Figure 1
shows an overview of USAID's microenterprise program, highlighting its
microfinance component. In fiscal year 2001, USAID-assisted institutions
served more than 2.8 million loan clients and

6World Bank, CGAP Report 2000, Consultative Group to Assist the Poorest
(Washington, D.C.: 2000).

more than 3.5 million savings clients. USAID-assisted institutions also
provided BDS to more than 800,000 microenterprise clients, including
market research, new product development and testing, technology
development, business counseling, and marketing assistance.

Figure 1: USAID's Microenterprise Development Program, Highlighting Microfinance
                                   Activities

                       Sources: GAO analysis and MapArt.

USAID's microenterprise development program, which is highly
decentralized, funded projects in 52 countries in 2001. USAID's missions
design, implement, and monitor the microenterprise projects, obligating
about 80 percent of the program's funding. In Washington, D.C., the
Microenterprise Development Division provides policy guidance and manages
a number of grants and, along with other USAID offices, provides about 20
percent of the agency's microenterprise funding. The division also
provides technical support for the missions and conducts research on
microenterprise issues.

USAID takes a collaborative approach in its microenterprise development
program. For example, USAID policy is to identify, support, and strengthen
existing MFIs with established performance records to help meet its
microenterprise objectives. It also funds studies of the MFIs it has
supported, to assess impacts and to identify best practices for both USAID
and the entire microenterprise industry. One major USAID research project,
Assessing the Impact of Microenterprise Services (AIMS), was initiated in
1995. Most of the AIMS studies focused on a single country or activity.
However, two recent AIMS studies examined USAID- and non-USAID-funded
microenterprise activities in seven countries7 and synthesized key
findings from a number of other studies,8 respectively.

USAID's microenterprise development program has targeted the poor and the
very poor (see fig. 2). The poor are those whose annual income is at or
below the poverty line as defined by the host country. The very poor are
those with an annual income 50 percent or more below the poverty line as
established by the government of the country. In addition, the vulnerable
nonpoor, who also receive microenterprise assistance, are those whose
annual income is just above the poverty line.

7Donald Snodgrass and Jennifer Sebstad, Clients in Context: The Impact of
The Microfinance in Three Countries-Synthesis Report (Washington, D.C.:
Management Systems International, 2002).

8Jennifer Sebstad and Monique Cohen, Microfinance, Risk Management, and
Poverty (Washington, D.C.: Management Systems International, 2000).

Figure 2: Conceptual Diagram of Populations along the Poverty Scale

Source: GAO.

Note: This diagram is for illustrative purposes only and is not drawn to
scale. The national poverty line is defined by each country.

Since 1994, USAID's policy has been to devote half of its microenterprise
development resources to activities targeting the very poor. In 2000, this
policy was established as law by the Microenterprise for Self-Reliance and
International Anti-Corruption Act of 2000, which required that 50 percent
of all microenterprise resources be targeted to very poor entrepreneurs.
From 1994 until the implementation of the 2000 legislation, USAID defined
loans to the very poor, or "poverty loans," as those with an average
balance of $300 or less per borrower (in 1994 dollars). The 2000
legislation established the loan level at $1,000 or less for Europe and
Eurasia, $400 or less for Latin America, and $300 or less in the rest of
the world.

USAID annually collects data on its microenterprise program through the
MRR. (See app. IV for a discussion of the MRR methodology.) Data are
collected through surveys of USAID staff in headquarters, overseas
missions, and institutions that receive USAID funding. USAID staff provide
the data on funding obligations, and implementing institutions provide
programmatic data on number and gender of clients, number of loans,

amount of lending to the very poor, MFI sustainability self-assessments,
BDS services provided, and policy initiatives.

In addition to the USAID-supported studies, a large body of published and
unpublished work has been generated by what is commonly referred to as the
microfinance industry. This research includes empirical studies, a broad
array of theoretical analyses, and materials on best practices. However,
because the industry is relatively new, large gaps exist in important
research areas. For example, experts generally agree that reliable and
valid impact assessments are lacking or limited in scope. (See app. III
for a review of 22 microenterprise studies.)

USAID's microfinance activities have achieved some of the agency's key
program objectives but made limited progress toward others. First,
microfinance can help to alleviate the effects of poverty among
participants. However, there is less evidence that microfinance has lifted
or kept large numbers above the poverty line as established by host
countries. Second, USAID's program has generally reached the poor but not
the very poor. Third, the program appears to have succeeded in encouraging
the participation of women through micro loans. Finally, USAID has
emphasized the importance of developing sustainable MFIs and has made some
progress toward this goal.

  USAID Has Met Some Program Objectives

    Microfinance Can Help Alleviate Some of Poverty's Impacts

Our fieldwork and review of USAID-funded studies and research literature
showed that microfinance can alleviate some of the impacts of poverty
among recipients.9 USAID officials, implementing partners, and borrowers
also concurred that it can help to mitigate some effects of poverty. Most
borrowers said that the microfinance institutions were their only formal
source of credit or savings and stated that the program helped improve
their lives, incomes, businesses, and sense of self-worth. (See fig. 3.)
The broader academic studies of microfinance we reviewed, as well as the
experts we consulted, generally agreed that micro loans can help poor
individuals, workers, and their families cope with personal and economic
shocks, such as illness or death of family members, and manage risks
associated with living in poverty. In addition, USAID officials noted that

9USAID generally supports and invests in MFIs and ongoing projects started
by NGOs or other groups. The research literature on microfinance and
USAID's own studies do not distinguish between USAID-funded projects and
projects funded by the World Bank, private foundations, or other donors.

microfinance projects are demand driven, put money directly into the hands
of the borrowers, and generally have loan repayment rates close to 100
percent. The experts with whom we spoke agreed that microfinance programs
can have other benefits, such as helping to build a nation's financial
sector.

Figure 3: Microentrepreneurs in Bulgaria

Source: GAO.

This husband-and-wife team manufactures and sells flavored popcorn with
the help of three employees. The husband borrowed $2,300 from a
USAID-funded MFI, which provides loans for individuals. The entrepreneurs
said that they used the loan to buy additional machinery for their
enterprise. (Stara Zagora, Bulgaria)

The studies we reviewed and experts we consulted also posited that
microfinance can help increase microentrepreneurs' working capital,
thereby enhancing their household income. However, positive impacts of
specific microfinance projects have been limited in scope and have varied
according to economic, social, and market conditions as well as the design
and aims underlying particular programs.

USAID-funded impact studies in two countries we visited, Peru and Egypt,
found some positive effects from microfinance. For example, the study in
Peru found that the program helped increase assets at the microenterprise
level; it also noted some positive effects at the household and individual

levels. According to the study, economic recession in Peru during 1997 and
1999 may have limited the effects of the small loans.10 A study in Egypt
found that a microfinance program offering group lending to poor women
helped its clients establish and expand their businesses.11 The loans also
enabled them to improve their standard of living by contributing to the
household budget, renovate their homes, and provide their children with a
better education through private tutors. (See fig. 4.)

10Elizabeth Dunn and J. Gordon Arbuckle, Jr., The Impacts of Microcredit:
A Case Study from Peru, (Washington, D.C.: USAID/AIMS, 2001).

11Bashayer El Kheir: An Impact Tracking Study (Final Report) (Washington,
D.C.: USAID, 2003). Another USAID study in Egypt was unable to draw firm
conclusions about the impact on poverty alleviation, because, although it
noted some positive findings, the study lacked baseline data as well as a
control group (see USAID, Technical Assistance to Small and Emerging
Business Development Organizations: Study on Old Clients

[Washington, D.C.: 2001]).

     Figure 4: Microentrepreneurs with Loans from Various USAID-funded MFIs

                                  Source: GAO.

Although microfinance can help alleviate some of the impacts of poverty,
the research literature does not show conclusively that it has lifted
large numbers of people above the poverty line. In our review, we
identified two studies on this issue. The 2002 AIMS study-examining
microfinance projects in three countries, two of which were USAID
supported-found that "there was no dramatic movement of client households
out of poverty over the two-year span of the study."12 The second study
analyzed the three major microfinance programs in Bangladesh-two of which
received USAID funding in fiscal year 1998-and found that about 5 percent
of program participants per year rose above the poverty line during the
period covered by the study.13

The experts we consulted generally agreed that although microfinance can
help to alleviate some of poverty's impacts, too few long-term studies
have been conducted to determine whether microfinance can lift, and keep,
significant numbers of clients above the poverty line. These experts also
emphasized that because the poverty line is a problematic and somewhat
artificial measure, most impact studies have not focused on estimating the
number of borrowers who cross and remain above it. The experts and
practitioners we interviewed and whose work we reviewed now generally
conclude that microfinance alone is not sufficient to lift large numbers
of people out of poverty. The challenges the poor face-limited education,
few opportunities, legal and cultural barriers-are difficult to overcome
with micro loans. Moving out of poverty usually requires a combination of
strategies by different household members, and, according to a USAID
program official, "backsliding is possible and even frequent."

Most USAID Funding Has Although the agency's microfinance activities serve
the poor, they Reached the Poor but Not generally appear not to reach the
very poor, according to our review of the Very Poor USAID studies and the
research literature. In addition, as mandated by the

Microenterprise for Self-Reliance and International Anti-Corruption Act of
2000, the agency uses small loan size as an indicator of loans to the very
poor; however, this is now generally considered an inadequate measure of
success in reaching that population. Moreover, some evidence suggests

12Donald Snodgrass and Jennifer Sebstad, Clients in Context: The Impact of
The Microfinance in Three Countries- Synthesis Report (Washington, D.C.:
Management Systems International, 2002), p. 65.

13Shahidur Khandker, Fighting Poverty with Microcredit: Experience in
Bangladesh. (New York: Oxford University Press, Inc., 1998).

USAID's Microfinance Activities Generally Have Not Reached the Very Poor

that micro loans can have unintended negative consequences among very poor
borrowers. Finally, meeting the requirement of targeting 50 percent of
microenterprise resources to the very poor could hamper MFI
sustainability.

USAID studies and other research literature on microfinance show that
microfinance activities serve those clustered just above and below the
poverty line but generally do not reach the very poor. According to the
2002 USAID-funded AIMS study, based on work in three countries, both the
vulnerable nonpoor and the poor participate in the program, with the very
poor making limited use of USAID-supported microfinance services. The 2000
AIMS study14 reported that in the projects studied in four countries, the
majority of clients were poor, followed by the vulnerable nonpoor. This
study also found that approximately 40 percent of USAID microfinance
clients in Bangladesh were very poor but that in Bolivia, the Philippines,
and Uganda, the number of very poor ranged from "almost none" to "some,"
although it did not quantify the precise numbers. In addition, the 2000
AIMS study noted that 20 other microfinance impact studies had found
limited participation by the very poor.

The broader literature on microfinance confirms that the microfinance
industry has reached the poor and vulnerable nonpoor but relatively few of
the very poor. For example, one widely cited study15 found that
microfinance lenders in Bolivia tended to serve those near the poverty
line, not the very poor. During our fieldwork, representatives from USAID
and their implementing partners told us, based on their experience with
the program, that few loans went to the very poor-a finding generally
consistent with academic studies of projects in other countries. USAID
officials in the countries we visited said that the very poor rarely take
out loans because they may lack the economic opportunities to repay the
loans and are reluctant to increase their debt levels. According to the
2000 AIMS study, not enough information is available to determine whether
(1) the very poor choose not to borrow to avoid additional debt; (2) MFI
staff disqualify the very poor because of concern over their ability to
repay the loans; or (3) other types of loans and services, such as savings
or insurance, would better meet the needs of the very poor.

14Sebstad and Cohen, Microfinance, Risk Management, and Poverty.

15Sergio Navajas et al., "Microcredit and the Poorest of the Poor: Theory
and Evidence from Bolivia," World Development 28, no. 2 (2000): 333-346.

Small Loan Size an Inadequate Measure of Whether Loans Reach the Very Poor

Loans to Very Poor May Be Ineffective Unless Combined with Other Services

Although most MFIs use small loan size as an indicator of loans to the
very poor (as mandated in the 2000 act), in practice this is an inadequate
method. It is based on the assumption that small loans appeal only to the
very poor, and it is widely used in part because it is easy to administer.
However, many practitioners, including USAID, now generally consider loan
size an inadequate indicator of clients' level of poverty.

In June 2003, legislation was enacted amending the Microenterprise for
Self-Reliance and International Anti-Corruption Act of 2000 to ensure the
development of more precise poverty measurement tools.16 The amendments
required USAID to develop, test, and certify at least two lowcost methods
for determining recipients' poverty level by October 1, 2004, and begin
using one of the methods by October 1, 2005. The amendments also expanded
the definition of the very poor to specifically include those living on
less than $1 per day.

Although some evidence suggests that micro loans may help alleviate the
impacts of poverty, evidence also suggests that in some cases these loans
may affect very poor borrowers more negatively than positively and may be
more effective in combination with complementary services. Within the
microfinance industry, little consensus exists about the effectiveness of
micro loans to the very poor. USAID officials in the countries we visited
stated that economic and social impediments in those countries often make
loan repayment difficult for the very poor. In Peru, a representative of a
large U.S.-based implementing partner told us that her organization
typically does not lend to the very poor, considering social services, not
loans, more appropriate for that population. In Egypt, one of the largest
USAID-supported MFIs said that it has started a separate grant program to
reach the very poor. USAID officials in Bulgaria we visited said that the
poor were more able than the very poor to expand their enterprises and, as
a result, to hire the very poor. In addition, a USAID program official
stated that microfinance might not always be an appropriate intervention
for the very poor, since they often cannot use the loans productively.

Some research also indicates that micro loans alone may not be an
appropriate assistance mechanism for people below a certain level of
poverty because they may increase their debt to unmanageable levels. Other
research has attempted to show that with a strong commitment to

16PL 108-31, enacted June 17, 2003.

reaching the very poor, and with a well-targeted program attuned to the
needs of very poor clients, microfinance can have positive impacts.17

At the same time, recent studies suggest that to reach the very poor, the
microfinance industry needs to move beyond loans and offer the very poor
other services, such as savings and insurance. 18 For example, a 2002
strategic evaluation of the Consultative Group to Assist the Poorest
(CGAP)19 stated that savings may be the most important financial service
for the very poor, since it provides a way to accumulate money without
risking debilitating indebtedness. In addition, the 2002 AIMS report and
other research indicated that, because of difficulties in reaching the
very poor with micro loans and the potential for indebtedness, there is a
need to expand the type of products or assistance targeted to this group.
These products can include savings, insurance, and money transfer
services; nonfinancial business development services; and reforms of key
policies, programs, institutions, and regulations that can affect the very
poor. Last, a 2003 CGAP publication states that donor funding for
microfinance should complement, not substitute, for investments in core
services, like health, education, and infrastructure,20 a view that also
reflects USAID's policy, according to agency officials.

USAID officials stated that implementing the requirement that 50 percent
of funds be targeted to the very poor, based on the loan sizes set by the
2000 act, could make individual MFI sustainability more difficult to
achieve. Officials at the missions we visited said that their primary
objective was to develop sustainable MFIs. In Bulgaria, officials with
USAID and its implementing partners, Catholic Relief Services (CRS) and
Opportunity International, said that imposing this requirement on
individual MFIs could create unsustainable institutions, because managing
a high percentage of small loans would increase costs associated with
servicing these loans. The mission in Egypt, which began its microfinance

Poverty Lending Requirement May Hamper MFI Sustainability

17Research that attempts to find a middle ground between sustainability-
and povertyorientations is reflected in Morduch (2000), Woller, Dunford,
and Woodworth (2000), and Cohen (2002). (See app. III.)

18Evaluation and Strategic Review of the Consultative Group to Assist the
Poor (Washington, D.C.: The World Bank, 2002), p. 16. (See also
Rutherford, 2000; Matin, Hulme, and Rutherford, 2002; Cohen, 2002, in app.
III.)

19CGAP, a consortium funded by 29 bilateral and multilateral donor
agencies that support microfinance, is affiliated with the World Bank.

20Donor Brief, No. 13, July 2003, CGAP.

program in 1988, did not offer poverty lending until 1999, when it judged
that the institutions it supported were financially viable and stable
enough to begin making such loans.21

The research literature we reviewed also indicates that MFIs that are
considered financially sustainable generally do not reach the very poor in
large numbers. Our analysis of data in the MicroBanking Bulletin, a
publication in which MFIs report financial and programmatic information,
indicate a direct correlation between larger average loan size and
increased financial sustainability (see fig. 5). Further, according to a
CGAP assessment, donor confidence during the mid-to-late 1990s that most
MFIs could both reach the very poor and become sustainable has since
declined.

Figure 5: Financial Sustainability of Institutions, by Average Loan Size

Percentage of financial sustainability

120

100	Full financial sustainability

80

60

40

20

0

Small Medium Large ($135) ($755) ($1,420) n=58 n=77 n=6

Institutions, by average loan size

Source: GAO analysis of data from the MicroBanking Bulletin (November
2002).

Note: MFIs are considered financially sustainable when they can cover 100
percent of their costs, as well as the cost of borrowing funds at
commercial rates.

A USAID program official said that the poverty lending requirement can
work against the goal of developing sustainable MFIs, since it directs the
agency to target half of its resources to those may be least able to repay

21USAID applies the poverty lending requirement on an agency wide basis.
However, it does not ask that individual missions or MFIs meet this
requirement.

the loans. The official added that by focusing its resources on the poor
and the vulnerable nonpoor, who can use loans more productively, the
agency could increase the likelihood of developing sustainable
institutions.

USAID's Microfinance USAID data indicate that the agency succeeded in
reaching large numbers Activities Have Reached of women clients through
its microcredit activities in fiscal years 1997 to Many Women 2001 (see
fig. 6).22

Figure 6: Clients in USAID-funded Micro Loan Projects, by Gender,
1997-2001

                      Number of clients in thousands 4,000

                                     3,500

                                     3,000

                                     2,500

                                     2,000

                                     1,500

                                  1,000 500 0

1997 1998 1999 2000 2001 Fiscal year

Male clients

Female clients

                      Source: GAO analysis of USAID data.

The broader research literature we reviewed shows that micro credit
activities have successfully targeted women. Generally, the literature
suggests that female clients have had better loan repayment rates and
lower default rates than male clients. Microcredit services are of
considerable importance to poorer women, who tend to have more limited

22USAID also reaches a large number of savers through its microfinance
program. According to USAID data for 2001, the program reached 3.5 million
savers, compared with 2.9 million borrowers. However, the proportion of
women reached through micro savings services cannot be determined, because
USAID does not collect savings data disaggregated by gender.

access to other financial services than men. Research also shows that
micro loans have generally improved female clients' participation in
decision making at the household and business levels.23

Our fieldwork indicated that USAID-supported MFIs' focus on women varied
by country and project type. In fiscal year 2001, more than twothirds of
the USAID-funded MFI micro loan clients in Peru were women, and in Egypt
and Bulgaria, just under half of those clients were women. Within these
countries, we found that project design affected women's participation
rates. Projects employing group lending24 or offering nonfinancial
incentives, such as health care, tended to have a higher percentage of
female clients. For example, as a result of group lending projects that
began in 1999 for women from poor communities, the overall percentage of
women clients across USAID-funded microfinance activities in Egypt
increased from 17 percent in fiscal year 2000 to about 45 percent in
fiscal year 2001. In Peru, MFIs such as ProMujer, whose clients are nearly
all women, offer borrowers group loans, day care, health education, and
medical referral services. (See fig. 7.)

23Several studies indicate that in some cases, micro loans have not
empowered women but instead have strengthened traditional gender and class
power relations. However, this conclusion does not represent the general
agreement among experts we consulted that, on the whole, micro loans have
had a positive effect on women.

24Under the group lending model, 5 to 30 members receive a loan and future
loans to individual members are contingent on the entire group's repayment
record.

           Figure 7: Women Entrepreneurs at USAID-funded MFIs in Peru

                                  Source: GAO.

    Some Progress Made toward MFI Sustainability

USAID Has Emphasized MFI Sustainability

USAID-Funded MFIs Report Some Progress toward Full Sustainability

USAID has emphasized developing sustainable MFIs, and available data
suggest that some progress has been made toward this goal. In fiscal year
2001, of the 294 USAID-funded MFIs that reported sustainability levels,
112 stated that they had achieved full sustainability. USAID does not
collect sustainability data from MFIs that no longer receive funding. As a
result, it lacks the long-term data needed to determine whether MFIs it
has supported have continued to provide services in a sustainable manner
and if so, for how long. The research literature we reviewed indicates
that achieving full sustainability has been difficult for the broader
microfinance industry. Further, the literature indicates that fully
sustainable MFIs tend to reach larger numbers of borrowers. Finally, MFI
sustainability can be transient, subject to factors such as mismanagement
and economic shocks.

Within the microfinance industry, USAID is a leader in promoting MFI
sustainability. Before receiving USAID funding, an MFI must provide a plan
outlining the major steps it will take to achieve sustainability. USAID
expects MFIs to attain full sustainability within 7 years of receiving
USAID assistance. USAID and other donors consider sustainability to be an
important goal because it requires that MFIs manage operations efficiently
and meet clients' needs consistently. Further, achieving sustainability
allows institutions to continue providing services after donor funding
ceases. According to one CGAP official, "Aiming for sustainability is
paramount."

USAID determines an MFI's progress in achieving full sustainability by
using an interim measure it calls operational sustainability. An MFI is
considered operationally sustainable if revenues from interest and fees
cover all of its operational expenses, including salaries and other
administrative expenses. To be considered fully sustainable, the
organization must cover both its operational and financial costs, such as
the cost of borrowing funds at commercial interest rates, while taking
into account inflation and any subsidies.

Available data suggest that USAID-supported MFIs have made some progress
toward achieving full sustainability. In fiscal year 2001, 294
USAID-supported MFIs reported sustainability levels;25 of these, 112, or
38 percent, said that they were fully sustainable, a percentage that had

25USAID provided funding to 492 organizations in fiscal 2001. The agency
does not disaggregate these data by MFIs, BDS providers, or policy
advocacy organizations.

remained consistent since 1999.26 Because USAID does not monitor MFI
sustainability once its funding stops, it lacks long-term data to
determine whether the MFIs it has supported continue to be sustainable,
and if so, for how long.

To assess trends in MFI sustainability, we analyzed MRR data from 1995 to
2001; 45 MFIs reported sustainability data for both 1995 and 2001. Of
these, 15 (33 percent) reported reaching full sustainability at the time
of the 2001 survey. These percentages are similar to the percentage
reported for a 2002 MicroBanking Bulletin survey of established MFIs27 but
higher than those reported for the overall microfinance industry.
According to officials from CGAP, the Foundation for International
Community Assistance, and Americans for Community Cooperation in Other
Nations (ACCION), of the approximately 10,000 MFIs currently operating,
the number that are sustainable or are expected to survive in the long
term ranges from an estimated "few dozen"28 to 250. However, those MFIs
that are currently reported as sustainable serve about 80 percent of the
total microfinance clients worldwide, according to these officials. The
experts we interviewed agreed that the majority of microfinance clients
are served by a few large, sustainable MFIs.

In some cases, USAID has continued to fund MFIs that reported achieving
full sustainability and MFIs that did not achieve sustainability within 7
years of receiving USAID funding. USAID officials said that the primary
reason for continuing to fund these MFIs is to expand microfinance
services to new areas. For example, in Egypt, one of the institutions
listed as financially sustainable has received USAID funding for 14 years
to support expansion, according to mission officials. In Bulgaria, an
institution that had not attained operational sustainability received
USAID funding for fiscal years 1995 to 2003 and is expected to continue
receiving support until fiscal year 2006, when USAID is expected to end
its microenterprise activities in that country. USAID officials in
Bulgaria said

26To the extent that financially stable institutions are more likely to
report sustainability data, this percentage may be biased upward.

27In the 2002 survey of 147 MFIs, 42 percent reported full sustainability.
The MFIs participated in the survey voluntarily. (See "Bulletin Tables"
[data annex], MicroBanking Bulletin 8 (2002).

28James W. Fox, Mark Havers, and Klaus Maurer, Evaluation and Strategic
Review of The Consultative Group to Assist the Poorest (Washington, D.C.,
The World Bank: 2002), p.iv.

that the country's macroeconomic and financial instability, along with
regulatory and legal hurdles, has adversely affected MFIs.

The research literature we reviewed indicates that a large majority of
existing MFIs are not, and are not expected to become, fully sustainable.
The literature further indicates that MFIs with a large number of clients
have higher levels of financial self-sufficiency and profitability than
smaller MFIs. For example, Bank Rakyat Indonesia's Micro Division had
about 2.8 million borrowers and 27 million savings depositors in fiscal
year 2001 and has reported full financial sustainability since the early
1990s. In addition, data reported in the MicroBanking Bulletin, based on
financial and portfolio data of leading microfinance institutions
worldwide, indicate that institutions with a large loan portfolio and
number of clients have higher levels of financial sustainability than
smaller institutions (see fig. 8).

Figure 8: Financial Sustainability of MFIs, by Average Number of Borrowers

Percentage of financial sustainability

120

100	Full financial sustainability

80

60

40

20

0

Small Medium Large (4,519) (14,650) (165,175) n=42 n=75 n=30

Microfinance institutions (average number of borrowers)

Source: GAO analysis of MicroBanking Bulletin data (November 2002).

Note: MicroBanking Bulletin defines MFI size by the average number of
borrowers.

MFIs are considered financially sustainable when they can cover 100
percent of their operating costs, as well as the cost of borrowing funds
at commercial rates.

    MFI Sustainability Can Be Transient

In analyzing the status of 81 USAID-funded MFIs that reported on financial
sustainability over a 5- to 7-year period, we found that over one-fifth
(18) reported achieving full sustainability but later reported that they
were no longer fully sustainable. MFI sustainability can change rapidly
because of various factors, as the following examples from Peru
illustrate.

o  	PRISMA, one of the largest USAID-funded MFIs, became unsustainable
because of mismanagement and the theft of $2 million by employees. (USAID
officials said that steps had been taken to recover the funds and that
PRISMA will remain ineligible for future support until this situation is
resolved.)

o  	CARITAS, an MFI affiliated with Catholic Relief Services, experienced
declines in full sustainability at five29 of its eight branches during a
19month period. Over the next 4 months, the sustainability of two branches
improved, but during the subsequent 23-month period, lenient loan
repayment practices at three branches resulted in a significant decline in
sustainability and a consequent decline in portfolio quality at those
branches.

External factors such as hyperinflation, host country policy, and
regulatory environment can also significantly affect MFI sustainability.
For example, a 2002 USAID-funded study concluded that in Bulgaria, the
effective ability of the three USAID-supported MFIs "to continue probably
expires with the ending of their donor program unless their full [legal] .
. . and regulatory status is resolved."30 The study noted that for the
most promising of the three MFIs, Bulgaria's restriction on attracting
savings from borrowers or others was a major barrier to sustainability. In
addition, a USAID official stated that the devaluation of the U.S. dollar,
among other factors, contributed to a 14 percent drop in operational
sustainability at

29Two branches that had been fully sustainable experienced significant
declines in sustainability (49 percent and 14 percent, respectively), but
managed to remain sustainable, albeit at a lower level.

30Bulgaria Microfinance Assessment (Arlington, VA: The Peoples' Group,
Ltd., 2002), p. 8.

  MRR Data Generally Reliable but May Not Accurately Reflect USAID's
  Microenterprise Activities

this MFI between fiscal year 2001 and fiscal year 2002, because loans were
disbursed in dollars but collected in the local currency.

Although the basic data collected for USAID's MRR are generally reliable,
certain methodological problems may impede accurate reporting on the
agency's progress in meeting key goals. Specifically, it may not be
reporting accurately (1) the actual amounts obligated to microenterprise
activities, (2) whether 50 percent of USAID's resources went to the very
poor, and (3) the sustainability of USAID-supported MFIs. Moreover,
although the annual MRR reports on the overall activities of MFIs that
receive any USAID monies, it does not provide sufficient data on USAID's
contribution to MFIs and other service providers.

    Basic MRR Data Are Generally Reliable

We assessed the reliability of basic MRR data in terms of accuracy,
completeness, and consistency and found that they generally met these
criteria (see app. I for our methodology and app. IV for a discussion of
the MRR). These data include the number of clients, the percentage of
women clients, and the dollar amounts of the institutions' portfolios.
USAID collects most of the data via surveys filled out by the institutions
receiving USAID assistance. According to the contractor responsible for
collecting and analyzing the MRR data, the survey questions for
institutions were pretested and should be understood by respondents. (The
survey is available in English, Spanish, and French.)

The contractor and USAID officials stated that they review the data for
completeness, accuracy, and consistency. MRR staff reported that they
compared current and past year survey responses to identify inconsistent
responses and investigated these responses as warranted. Although two of
the three USAID missions we visited did not perform the checks recommended
by USAID's policy guidance, most of the data we examined were generally
accurate.

Reliability of Obligations We observed several problems with the reporting
of USAID's obligations

Data Is Uncertain 	that may affect the reliability of the data in the MRR.
First, the 2001 MRR publication includes obligations for many clients and
institutions that do not meet the MRR's definition of a microenterprise as
"compris[ing] 10 or fewer employees, including unpaid family workers, in
which the owner/operator of the enterprise . . . is considered poor."31
For example, of

31USAID, Microenterprise Results Reporting for 2001 (Washington, DC: 2003)
p.4.

the roughly 120 institutions that reported BDS and policy development
programs in the 2001 MRR publication, more than half reported serving some
clients whose incomes were above the national poverty line or who owned
businesses that were not microenterprises. In addition, at least onethird
of all BDS clients included in the MRR in 2001 had estimated incomes above
the poverty line. Furthermore, in Peru, an institution that had received
an obligation of $1.2 million in 2001 reported all its clients to the MRR,
even though only about one-third of its clients were microentrepreneurs.
Finally, almost a quarter (12 of 42) of the USAIDsupported MFIs in Eastern
Europe reported to the MRR loans exceeding $10,000, despite the regional
loan size limit of $10,000.

Second, underreporting of microenterprise obligations in the MRR may
occur. According to the USAID contractor, some of the missions that report
may not list all obligations for microenterprise activities. For example,
in 2000, the contractor who collects the MRR data found $7 million of
underreported microenterprise obligations, which was subsequently included
in the obligations totals.

In addition, the MRR does not track expenditures for its microenterprise
programs, and obligations reported to the MRR may not accurately reflect
actual program expenditures. During our fieldwork, we found situations
where obligations differed significantly from actual expenditures. For
example, for fiscal years 1991 to 2000, the MRR reported obligations of
about $160 million to microenterprise programs at the USAID mission in
Egypt. However, mission officials told us that the program actually spent
about 50 percent of this obligation.

    Estimate of Obligated Funds Going to the Very Poor May Be Inaccurate

USAID reported that 53 percent of its obligated microenterprise funds went
to the very poor in fiscal years 2000 and 2001. However, our analysis
indicates that the MRR may not accurately estimate the percentage of
microenterprise development funding that is targeted to the very poor. We
found the following limitations:

o  	The MRR lacks information on poverty lending for a significant portion
of total microenterprise obligations. In fiscal year 2000, it had data for
only 32 percent of obligations, and for fiscal year 2001, it had data for
only 41 percent of obligations (see fig. 9).

Figure 9: Available USAID Obligations Data for Poverty Lending, Fiscal
Years 2000 and 2001

Obligations in millions of dollars

180

160

140

120

100

80

60

40

20

0 2000 2001 Fiscal year

No data

Available data

Source: GAO analysis of USAID data.

Note: In fiscal year 2000, an estimated $28.5 million in loans went to the
very poor, and in fiscal year 2001, an estimated $34.2 million in loans
went to the very poor.

o  	USAID's method for calculating overall poverty lending extrapolates
from the available data and assumes that institutions that did not respond
to the MFI survey provided the same amounts of poverty lending as those
that did respond. However, unlike the respondents, many of the
nonrespondents did not make loans or performed activities that were not
directly involved with poverty lending. Nonrespondent activities, which
totaled $94 million-roughly 60 percent of the total fiscal year 2001
obligations-included a range of services. For example, in 2001, USAID
obligated about $5 million to support its microenterprise staff and about
$2 million for research and other support activities.

o  	Many BDS programs that report on outreach to the very poor are likely
to provide inaccurate data. While MFIs report the dollar value of poverty
loans they have made, many BDS providers must estimate and report the
number of their clients who have received poverty loans from any
source-data that, according to a USAID program official, the BDS providers
often lack.

According to a USAID program official, the agency went to considerable
effort to collect data from institutions that make poverty loans. USAID

officials acknowledged that it is difficult to estimate future poverty
lending for institutions that have not yet begun to make poverty loans and
those that provide services rather than loans to clients. However, USAID's
annual MRR report does not inform the reader of the extent or impact of
these limitations.

    MFI Sustainability Data May Not Be Reliable

Because USAID-supported MFIs use different definitions to calculate
sustainability, the sustainability data reported in the MRR may not be
reliable. USAID supplies differing definitions of sustainability, one for
the MRR and one for its Implementation Grant Program awards. In addition,
not all MFIs reporting to the MRR use the definition suggested there; for
example, one MFI with affiliates in more than 20 countries requires its
affiliates to report sustainability to the MRR using a more stringent
definition. Further, MFIs can and do interpret the underlying MRR
definition of sustainability differently; for example, some basic terms
such as "financial costs" are not defined and are subject to various
interpretations. As a result, the contractor responsible for collecting
and analyzing these data stated that they should not be considered
reliable.

    MRR Does Not Provide Sufficient Data on USAID's Contributions

The MRR does not provide information on USAID's level of contributions to
MFIs and other service providers it supports, making it difficult to
determine the scope of the agency's microenterprise development funding.
The MRR reports an MFI's total number of clients and loans, regardless of
the level of USAID's contribution to that MFI. For example, in 2000, USAID
obligated $400,000 to an MFI in Ecuador that reported loans of $80 million
and $477,000 to an MFI in Senegal that reported loans of $336,000. As a
result, the annual report lists a large number of clients, loans, and
other activities that were not funded by USAID and in many cases were
funded by other donors, foundations, and private individuals.

In addition, USAID requires institutions that provide technical assistance
to MFIs to complete the MFI survey. Because these technical assistance
providers make no loans, reporting the number of loans and clients served
by the MFIs they assist may provide an inaccurate impression of USAID's
micro lending activities. For example, we found that the institution
listed as in the MRR as the largest lender in Peru in 2001 did not make
any loans or serve any clients directly. Instead, it provided technical
assistance to more than 20 MFIs. However, the MRR reported that this
institution had a $37 million loan portfolio and 20,000 clients. According
to the contractor responsible for the MRR, USAID is relying increasingly
on technical assistance providers that serve lending institutions.

  USAID Has Identified and Disseminated Best Practices

USAID has funded several studies and projects, such as the Microenterprise
Best Practices project, to publish emerging best practices. In addition,
the agency has provided information on best practices to missions and
implementing partners through policy guidance, training, and technical
assistance. USAID has also collaborated with implementing organizations,
microenterprise networks, and donors in disseminating information on best
practices. Several organizations have published such information,
including USAID; the Committee of Donor Agencies for Small Enterprise
Development, whose secretariat is hosted and staffed by the World Bank;
the Donor's Working Group on Financial Sector Development; Catholic Relief
Services (CRS); and ACCION. (See app. II for a list of some key best
practices.)

USAID Has Made Efforts According to officials from the World Bank and
other organizations, to Identify and USAID has recognized the importance
of identifying and disseminating Disseminate Best Practices successful and
unsuccessful attempts to design and implement

microenterprise activities. USAID's efforts include the following.

o  	Growth and Equity through Microenterprise Investments and Institutions
(GEMINI). Through its GEMINI project, which ended in 1995, USAID supported
more than 120 studies on microenterprise development to publicize the
experiences of leading microenterprise practitioners and experts in
analyzing and managing microenterprise activities. These studies focused
on the growth and dynamics of microenterprise in general and new
approaches to delivering financial and nonfinancial assistance. The
studies included data collection strategies for surveys; strategies for
MFIs in Indonesia to more profitably provide financial services to the
poor, strategies for MFIs to help microenterprises grow into small
enterprises, recommended options to improve support for microenterprise
development in Ecuador, and analyses of the importance of providing needed
equipment to MFIs.

o  	Microenterprise Best Practices project. USAID funded the
Microenterprise Best Practices project, a research-oriented effort to
develop and disseminate best practices. The project, completed in 2001,
resulted in more than 100 reports, including concept papers, case studies,
and technical tools and manuals providing guidance for designing and
managing microenterprise activities. These reports included a model for
Internet-based information for microenterprises in the Philippines, a
description of Opportunity International's experience in Bulgaria and
Russia in managing a microfinance program during a period of high
inflation, a guide for reporting financial performance, and case studies
of

the difficulties encountered in converting nongovernmental institutions to
commercial banks in Bolivia and Panama.

o  	Guidance. USAID policy guidance for microenterprise development
encourages missions to develop broad outreach activities to as many of the
poor as possible, requires that MFIs charge unsubsidized interest rates to
borrowers to cover the cost of operations, advises that missions consider
and address host government policy constraints, and emphasizes the need
for steady movement toward sustainability to achieve significant impact
and institutional viability. Further, USAID policy states that missions
providing assistance for microenterprise development should monitor and
report on their outreach to the poor, including the distribution of its
loan portfolio by loan amount.

o  	Training. USAID supports training courses for its own and implementing
organizations' staff in designing and executing microenterprise
activities. In addition, USAID provides funding to the Microenterprise
Development Institute at Southern New Hampshire University and to Business
Development Services Training Program at the Springfield Centre in Durham,
United Kingdom, to support their microenterprise development training
programs. USAID's Accelerated Microenterprise Advancement Project provides
scholarships to USAID staff for microenterprise development training and
exchange programs. USAID also provides funding to the Small Enterprise
Education and Promotion Network (SEEP), a network of nongovernmental
organizations that implement microenterprise activities, for scholarships
to enable USAID employees and practitioners to attend SEEP's training
courses. During our fieldwork, we found that several USAID officials
working on microenterprise development had received training at these
locations.

o  	Technical assistance. USAID's Prime Grant project provides direct
technical assistance to missions in planning microenterprise activities.
The project provides information on advances in microenterprise
development and lessons learned from the missions' counterparts throughout
the agency. USAID's Accelerated Microenterprise Advancement Project
provides missions technical assistance from microenterprise experts and
information on ongoing research and learning in microenterprise
development. Missions may also receive technical assistance in developing
scopes of work, including sample scopes, and ongoing support throughout
the procurement process.

    USAID Has Collaborated with Other Organizations in Identifying and Promoting
    Best Practices

USAID has collaborated with implementing partners, networks of
implementing organizations, and the World Bank in identifying and
promoting best practices. These organizations have published handbooks,
bulletins, and other documents on best practices; maintained Internet
sites devoted to best practices; and sponsored seminars and workshops. For
example:

o  	CRS and ACCION International, two USAID-supported nongovernmental
organizations, have published handbooks to assist in designing and
implementing microenterprise activities. CRS also established the
Microfinance Alliance for Global Impact project to help its implementing
institutions strengthen their activities. The Foundation for International
Community Assistance produced an evaluation of current practices used by
microfinance institutions in assessing client poverty levels. Implementing
partners such as ACCION International and Opportunity International also
sponsor regional conferences, workshops, and seminars on best practices.

o  	USAID has provided funding to SEEP to support its efforts to promote
best practices. According to SEEP's Executive Director, USAID has been one
of its leading supporters, providing funding and technical assistance and
participating in the network's conferences and workshops. SEEP has
published two studies on microenterprise best practices.32 The network
also sponsors conferences and workshops on improving microenterprise
activities.

o  	USAID is a member of the World Bank's Committee of Donor Agencies for
Small Enterprise Development and Donor's Working Group on Financial Sector
Development, which have published guiding principles for designing and
implementing microenterprise activities in 1995 and in 2001. The World
Bank has also published reports to support the design and implementation
of microenterprise activities, such as a handbook, to assist in
operational planning and internal audits of activities.33 The group also
provides information through MicroBanking Bulletin and the Microfinance
Information Exchange.

32Candace Nelson, Barbara McNelly, Kathleen Stack and Lawrence Yanovitch,
Village Banking: The State of the Practice (New York, NY: SEEP Network and
the United Nations Development Fund for Women, 1996); Craig Churchill,
Madeline Hirschland, and Judith Painter, New Directions in Poverty
Finance: Village Banking Revisited (Washington, D.C.: SEEP Network, 2002).

33Joann Ledgerwood, Microfinance Handbook: An Institutional and Financial
Perspective (Washington, D.C.: World Bank, 1998).

  Conclusion

Recommendation to USAID

  Agency Comments and Our Evaluation

We found that microenterprise projects-including those funded by USAID-can
help alleviate some of the impacts of poverty on individuals, households,
and families. However, evidence suggests that microfinance alone has not
lifted large numbers of the poor over the poverty line. In addition,
despite USAID's use of micro loans to target the very poor, as mandated,
few loans appear to be reaching this group, in part because loan size is
an inadequate targeting method. Other evidence suggests that loans to the
very poor can place some borrowers at risk of unmanageable debt and may be
more beneficial when offered with other financial services such as savings
and insurance and with development assistance such as grants, health
services, education, and housing. Efforts to reach the very poor that do
not recognize and address these key concerns may not be fully effective.

Despite the general reliability of its data, certain methodological
weaknesses in USAID's MRR system may prevent the agency from reporting
with precision its program expenditures, the percentage of its funds going
to the very poor, the percentage of MFIs that are sustainable, and the
extent of USAID's contributions to the institutions it supports.

We recommend that the Administrator of USAID review the agency's MRR
system with the goal of ensuring that its annual reporting is complete and
accurate. Specifically, the Administrator should review and reconsider the
methodologies used for collection, analysis, and reporting of data on
annual spending targets, outreach to the very poor, MFI sustainability,
and the contribution of USAID funding to the institutions it supports.

USAID provided written comments on a draft of this report (see app. V).
USAID concurred with the report's recommendation that it make improvements
in its MRR. The agency cited three points with which it took issue,
related to reaching the very poor, the sustainability of MFIs it supports,
and its reporting of contributions to institutions.

USAID stated that the number of small loans it had issued indicated that
it was reaching the very poor. As discussed in our report and acknowledged
in USAID's comments, loan size is now recognized as an inaccurate
indicator of the extent to which this program is reaching the very poor.
Given this limitation, we reviewed detailed impact studies that collected
information on borrowers' economic status (see app. III for a summary of
key studies on this topic); further verified this information through
detailed discussions with international experts, USAID officials, and
their

implementing partners working with USAID-funded programs; and conducted
detailed program reviews in three countries . The general consensus across
the studies, experts, and program implementers is that microfinance
projects serve those clustered around the poverty line but generally do
not reach the very poor.

USAID also stated that, contrary to our report, the agency uses a single
definition of sustainability, and it inferred that the sustainability data
reported in the MRR was accurate. We disagree with USAID on these points:
We documented several definitions and interpretations that affect the
reliability of the reported data, and we have added information to the
report to clarify our concern regarding the agency's method for measuring
microfinance institutions' sustainability. As noted in the report, 38
percent of MFIs that received USAID funding in fiscal year 2001 reported
that they had achieved financial sustainability. The higher figure cited
in USAID's response combined data on operational and financial
sustainability, despite the fact that operational sustainability is, by
USAID's definition, an interim measure toward the goal of achieving full
financial sustainability.

USAID stated that it would be difficult to allocate the microenterprise
accomplishments reported in the MRR between USAID and other donors.
However, it said that it plans to include more explicit language in the
MRR to indicate that results are generally reported for entire
institutions and that the resources of other donors and supporters
contributed to the results. In its comments, USAID also agreed to (1)
provide more explicit instructions on what activities to include in the
MRR; (2) revise the formula for estimating the extent of funding that
benefits the very poor and include in its annual report additional
language concerning the formula; (3) improve the accuracy of data on
obligations and poverty lending; and (4) adopt a new standardized
definition of sustainability if one is adopted by the field. We believe
that these improvements would be responsive to our recommendation and, if
made, could improve the accuracy and balance of the MRR.

We will send copies of this report to interested congressional committees
as well as the USAID Administrator. We will also make copies available to
others upon request. In addition, this report will be available at no
charge on the GAO Web site at http://www.gao.gov.

If you or your staff have any questions about this report, please contact
me at (202) 512-3149 or at [email protected]. Other contacts and staff
acknowledgments are listed in appendix VI.

Sincerely yours,

David B. Gootnick Director, International Affairs and Trade

                       Appendix I: Scope and Methodology

To determine whether the U.S. Agency for International Development's
(USAID) microenterprise development program is meeting its key objectives,
we first identified those objectives by reviewing the agency's policy
guidance and the pertinent legislation. We also held discussions with
USAID officials in Washington, DC. To determine the results of the
agency's microenterprise assistance, we met with officials and reviewed
documents from USAID and their implementing partners in Washington, Peru,
Egypt, and Bulgaria, and we met with program beneficiaries in these three
countries. We selected Peru and Egypt because they have mature programs
that have existed since the late 1980s and received high levels of USAID
obligations over the past 10 years. These countries also represent
culturally different areas (e.g., the program in Peru serves a large
indigenous population, and the primarily business-led program in Egypt
serves a combination of urban and rural areas). We selected Bulgaria
because the program was relatively new; per capita income and the gross
domestic product were high; and participants were reported by USAID to
have higher educational levels and to be operating different types of
businesses than in Africa, Asia, or Latin America. In addition, we
reviewed a broad range of program and academic studies on the issues and
conducted interviews and round-table discussions with academics and
practitioners who have expertise regarding the ability of microenterprise
activities to meet USAID's objectives. We also reviewed USAID studies that
pertained to countries we visited, as well as studies that assessed
project impact related to key program objectives. Because most available
USAID data and most of the research literature focuses on microfinance,
particularly micro loans, we concentrated our review primarily on this
aspect of microenterprise development.

To assess the reliability of the Microenterprise Results Reporting (MRR)
data, we reviewed the survey questionnaires that are used to collect the
data, noting strengths and weaknesses in the survey design. We also
conducted a variety of analyses of the MRR database. Our analyses focused
on the data on obligations supplied by the USAID missions and the data on
microenterprise activities supplied by microfinance institutions (MFI),
business development service (BDS) providers, and policy service providers
from 1995 through 2002. We conducted interviews focused on data
reliability with the contractor that manages the data collection and
analysis and drafts the MRR reports. In these interviews, we asked how the
survey data are collected, what quality checks are performed, and what
other internal controls are in place. On our field trips to Peru, Egypt,
and Bulgaria, we conducted data reliability interviews with officials at
all three USAID missions and at six institutions that had received USAID
funding. During our meetings with USAID missions and

Appendix I: Scope and Methodology

the institutions, we conducted spot checks of key MRR data to assess their
reliability. We found that the reliability of the lending and BDS
institutions' data on the percentage of women clients sufficed for our
analysis, provided we noted that some BDS providers could not directly
estimate these percentages. The data on lending institutions'
sustainability were of uncertain reliability because of inconsistencies in
the way respondents interpreted the MRR survey question; however, these
data were consistent with the testimonial and documentary evidence that we
gathered.

To examine USAID's role in identifying and disseminating best practices,
we reviewed (1) USAID policy guidance, (2) USAID country strategies and
annual reports for the three countries we visited, and (3) other relevant
USAID documents. We also reviewed a wide body of literature on the
subject, including World Bank publications and the MicroBanking Bulletin;
analyses of best practices produced by donor groups; handbooks, analyses,
and other documents produced by USAID implementing organizations such as
Catholic Relief Services and Opportunity International; and studies and
analyses by recognized microenterprise experts. We interviewed USAID
officials in the Microenterprise Development Division, the regional
bureaus that oversee mission activities, and the countries we visited,
including officers responsible for economic growth and microenterprise
activities. We also interviewed officials of the World Bank and from
implementing organizations in Washington, D.C.; Baltimore, Maryland; and
the countries we visited. Finally, we attended a roundtable on best
practices whose members included recognized experts on microenterprise
development from the World Bank, implementing organizations, and academia.
The World Bank also provided informal comments on a draft of this report.

We conducted our review from December 2002 through September 2003 in
accordance with generally accepted government auditing standards.

                  Appendix II: Microenterprise Best Practices

Best practices are processes, practices, and systems that have been used
by organizations and widely recognized as improving performance in
achieving program goals. Although the research literature and our
fieldwork indicate that no standard manual of best practices exists for
microenterprise development, a core of preferable strategies (best
practices) has emerged within the microenterprise industry comprising
USAID, other donors, and their implementing partners.

  Design-Related Best Practices

o  	Perform due diligence reviews. USAID officials require their
implementing partners to carefully review all candidates and to pay
particular attention to choosing institutions with strong management
skills. Officials from Catholic Relief Services (CRS), a nongovernmental
organization that manages a microenterprise activity in Bulgaria, chose
their implementing partner based on the partner's strong management
experience.

o  	Develop broad outreach. At USAID missions in Peru, Bulgaria, and
Egypt, microenterprise activities included provisions for small loans to
poor microentrepreneurs with no other affordable credit alternatives. A
USAIDsupported MFI in Egypt recently initiated a lending program that
specifically provides small loans to the poor and is instituting a grant
program to help the very poor become eligible for micro loans. In Peru, to
target the poor and very poor, USAID chose to implement microenterprise
activities in several of the country's poorest regions. USAID-supported
institutions in Bulgaria and Egypt offered financial incentives to loan
officers, based in part on the number of loans in their loan portfolio, to
encourage them to attract clients.

o  	Increase access to services. At implementing organizations in Peru,
Bulgaria, and Egypt, loan officers assist poor and very poor clients in
filling out the loan applications and attempt to review and approve loan
requests within a few days. In addition, because the poor usually lack the
collateral needed to qualify for loans, USAID supports collateral
substitution activities to attract the poor and very poor who would have
no other access to credit. USAID missions in Bulgaria, Egypt, and Peru
conduct microenterprise activities that used group lending as a collateral
substitute. For individual loans, an implementing organization in Bulgaria
require that clients obtain written loan guarantees from acquaintances as
a collateral substitute.

Appendix II: Microenterprise Best Practices

o  	Adopt an appropriate lending model. Some models, such as group lending
or village banking,1 may be more appropriate than individual lending
programs for certain activities or institutions. CRS adopted a group
lending model to serve the needs of the poor in Bulgaria. (This model also
supports the CRS goal of advancing social and economic justice by serving
the poorest.) A study of group lending activities in Africa, Asia, and
Latin America indicated that more successful group lending models vary
according to the local culture. For example, in South Africa, the South
African Get Ahead Foundation adapted the traditional African rotating
savings program to create similar group lending activities.

o  	Offer an array of services. In addition to credit, services such as
savings options and insurance are valuable to clients and, by providing
other revenue sources, can assist MFIs in reaching sustainability. In
Indonesia, a CRS MFI established a savings program in a village bank for
its microenterprise clients. ACCION International, using a group lending
model, has each member contribute a minimum amount to a common pool of
savings.

o  	Establish appropriate pricing policies for services. USAID requires
financial institutions that receive microenterprise funding, even those
that emphasize lending to the very poor, to charge unsubsidized interest
rates. For example, CRS specifies in its microenterprise handbook that the
MFIs it manages should charge unsubsidized interest rates. In Bulgaria,
Egypt, and Peru, the annual interest rates can be as high as 40 percent
annually, although the repayment period is often less than 1 year.

o  	Control loan delinquency rates. Loan delinquency rates greater than 10
percent have been found to seriously undermine MFI sustainability. Several
MFIs offer financial incentives to their loan officers partially based on
the repayment rates of their loan portfolio. MFIs in Peru, Bulgaria, and
Egypt use different methods to determine financial incentives to reward
their loan officers, but all base the amount of financial incentive on the
loan repayment rate of the officer's portfolio. At one implementing
organization in Egypt, loan officers must maintain at least a 97 percent
repayment rate on their loan portfolios to be eligible for financial
incentives. An MFI in Bulgaria that provides individual loans requires
that five people provide guarantees for each loan. The MFI also employs a
loan collection officer and an attorney to file in court to collect on
delinquent

1In group lending and village banking, group members, rather than an
individual, accept joint responsibility for repaying the loan.

                  Appendix II: Microenterprise Best Practices

loans. MFIs in Egypt and Bulgaria that focus on poverty lending use a
group lending model to provide for prompt loan repayment.

o  	Address potential policy constraints. USAID guidance advises missions
to consider the local economic environment when designing and implementing
microenterprise activities. For example, the guidance advises missions not
to provide assistance to MFIs during periods of high inflation. USAID
officials told us the agency suspended a microenterprise activity because
the Government of Egypt tax policies were too restrictive. Grant
agreements may also include a component focused on policy and regulatory
reforms to facilitate microenterprise activity. Such reforms may include
permitting financial institutions to offer savings to clients,
streamlining business registration procedures and assisting
microentrepreneurs in registering and obtaining title to their businesses'
assets. A USAID grant agreement in Bulgaria required the implementing
organization to coordinate efforts in legislation on policy reform within
3 years.

  Implementation-Related Best Practices

o  	Require transparency and accountability in operations. USAID requires
implementing partners and MFIs to report annually on financial and
operational performance. In Peru, a USAID-funded technical assistance
provider conducts audits of more than 40 MFIs to assess their
implementation-related practices.

o  	Provide adequate resources to successfully manage a microenterprise
activity. Effective management information systems and other assets are
necessary for implementing organizations and financial institutions to
make decisions, motivate performance, and provide accountability over
funds. USAID provides resources to help implementing partners and MFIs
improve their management capacity. For example, most USAID grant
agreements provide funding to rent office space, to purchase management
information systems, including the computers needed to track outstanding
loan balances and due dates, and to purchase other equipment such as
office furniture.

o  	Provide necessary training. Training for implementing organizations
and clients in areas such as financial management and computers is often
needed to ensure that MFIs manage operations effectively. USAID grant
agreements may provide funding for training of implementing organizations'
staff. Implementing organizations, such as an Opportunity
International-funded MFI in Colombia, includes weekly training of clients
in areas such as marketing and product presentation. A USAID-funded study
of five nongovernmental organizations implementing

Appendix II: Microenterprise Best Practices

microenterprise activities concluded that heavy investment in training was
a factor in the success of village banks.

o  	Provide incentives to loan officers. USAID-supported MFIs in Bulgaria
and Egypt provide loan officers incentive-based salaries. Criteria for the
incentives included the number of clients recruited and the clients' loan
repayment rates. Incentives can double loan officers' monthly earnings.

o  	Require a manageable loan portfolio for loan officers. Implementing
organizations in Bulgaria and Egypt, such as CRS and Opportunity
International, limit the number of clients one loan officer can manage.
The number can vary depending on the ability of the officer, but few
manage more than 300 clients. Also, because incentives are based primarily
on loan default rates, officers are motivated to limit their pool of
clients to a size they can manage effectively.

o  	Monitor and evaluate performance. Donors and implementing
organizations should monitor the performance of the MFIs they support to
ensure they are meeting program goals. These goals can include a focus on
the poor and women, as well as financial indicators, such as repayment
rates and progress toward sustainability. They should also perform audits
on a regular basis to ensure the accuracy of information reported. USAID
typically performs midterm and final evaluations of its grant agreements.
A cross-country study of village banks in seven countries concluded that
oversight of the banks' operations was a critical factor in their success.
Further, USAID requires annual financial reports of implementing
organizations.

o  	Promote MFI sustainability. This goal supports (1) sound financial
practices, (2) expanding and maintaining outreach, and (3) reducing
dependency on donor support. USAID and other implementing organizations
encourage MFIs to charge unsubsidized interest rates to cover the cost of
operations. A USAID-funded study of successful

Appendix II: Microenterprise Best Practices

microenterprise activities in Indonesia and Bangladesh concluded that MFIs
must have a commitment to, and a plan for, reaching sustainability.2

2Mohini Malhotra, Poverty Lending and Microenterprise Development: A
Clarification of the Issues, GEMINI Working Paper No. 30 (Washington,
D.C.: U.S. Agency for International Development, 1992).

Appendix III: Review of Microenterprise Studies

We collected, reviewed, and analyzed a set of 22 studies, 20 of which
provide an overview of existing research and practice in microenterprise
or its components. The purpose of our review was to obtain general
information on the primary findings, issues, and debates in microfinance
and microenterprise and to complement other USAID-specific components of
our data collection efforts.

We selected these studies on the basis of three criteria: (1) each study
was published in 1998 or later, (2) each was peer reviewed or published by
journals or publishers respected in the field, and (3) each was
recommended by 2 or more of 15 microfinance experts we consulted. We also
included two case studies (published and peer reviewed), because 5 or more
of the experts we consulted recommended them. We ensured that the studies
selected covered a range of microenterprise subtopics and scientific
journals relevant to economic and social development issues. A primary
reviewer summarized each study using a data collection instrument
developed specifically for the purposes of this review. A secondary
reviewer then verified each study summary.

We reviewed each of the 22 articles and summarized the findings and
relevant suggestions or recommendations, paying particular attention to
information on poverty impacts, outreach, women's empowerment,
sustainability, and best practices (see table 1). (Note: The
recommendations in the third column of the table are those of the studies'
authors and do not represent the viewpoint of GAO.)

                Appendix III: Review of Microenterprise Studies

Table 1: Findings and Recommendations from 22 Selected Studies on
Microfinance and Microenterprise Development

Author
title
source Primary findings Author recommendations

Bhatt, Nitin; Tang, Shui- o  Attempts to replicate best-practice models of
    o  The best solution for the
Yan. microfinance based on successful programs (Grameen, microfinance
industry is to have a
Delivering Microfinance BRI, BancoSol) have largely been disappointing.
diverse array of institutions that are

in Developing  o  Few programs have lived up to their original objective
of both non- and for-profit, subsidized
Countries: "including the excluded." and unsubsidized, and bare-bones

Controversies and  o  In most cases, subsidies have ended up funding and
integrated.
Policy Perspectives. inefficient and lax management practices that have  o
There is a need for better, more
2001. Policy Studies resulted in limited outreach, high loan default
rates, and accurate financial reporting and
Journal 29 (2): 319-333. unsustainable operations. cost-benefit analysis
in

microfinance.

Cohen, Monique.

Making Microfinance More Client-Led.

2002. Journal of International Development 14 (3): 335-50.

o  	The microfinance industry has been largely a single product industry;
this product has worked well for people around the poverty line but is
less effective at reaching the very poor.

o  	Although most MFIs serve a wide range of clients, the majority of
clients are clustered just above and just below the poverty line.

o  	Many poor people are highly indebted and microfinance loans are only
one component of the debt burden of many households.

o  	High drop-out rates in some places have arisen as competition between
MFIs has increased.

o  	Poverty-targeted programs tend to reach a higher percentage of lower
income clients; even here, poorer populations often exclude themselves
from microfinance programs.

o  	Many poor people "patch" together funds from a variety of sources,
including MFIs, in order to meet their consumption and investment needs.

o  	Most MFI management information systems lack adequate client
information that can be used as a tool in decision making and product
development.

o  	To achieve outreach to underserved market segments and to the very
poor, the microfinance industry must focus on clients' specific financial
needs and design appropriate financial services accordingly.

                Appendix III: Review of Microenterprise Studies

3 	Steven Haggblade; Mead, Donald C.; Meyer, Richard.

An Overview of Policies and Programs for Promoting Growth of the Rural
Nonfarm Economy.

Forthcoming. In Developing the Rural Nonfarm Economy, edited by Steve
Haggblade, Peter Hazel, and Thomas Reardon.

o  	In analyses of the impacts of micro loan programs on rural nonfarm
economies, outreach has proven impressive, financial sustainability has
proven elusive, and income increases have been generally documented at the
household and firm levels, particularly for the better-off poor and in
Asia.

o  	Micro loans have not advanced our understanding of the challenge of
lending to enterprises in rural areas where population densities are lower
and where the seasonality in cash flows and lending costs is higher.

o  	Business development services involving the delivery of nonfinancial
services to rural nonfarm enterprises are more heterogeneous, more
problematic, and have produced decidedly fewer results than the delivery
of financial services to rural nonfarm enterprises.

o  	In the future, improvements in rural welfare will need to go beyond
financial markets and services to develop new engines of economic growth,
new technologies, and new ways of doing business.

o  	A focus on subsectors, supply chains, and clusters can lead to
tailored systemic interventions that unleash growth potential for large
numbers of rural firms.

Hulme, David.  o  Microfinance impact assessments vary greatly in their  o
    Impact assessments must be Impact Assessment range, rigor, and
practicality; there have been relatively tailored to the resources, needs,
Methodologies for few quasi-experimental, control-treatment studies, and
and time frames defined by the Microfinance: Theory, practitioners have
found such studies to be expensive program's context.

and difficult to use.

Experience, and Better
Practice.  o  There is increasing movement toward mixed studies

incorporating quantitative and qualitative elements and2000. World
Development toward designing impact assessment activities into28 (1):
79-98. microfinance programs.

Khandker, Shahidur R.

Fighting Poverty with Microcredit: Experience in Bangladesh.

1998. New York: Oxford University Press.

o  	Globally, micro loan programs have been able to reach the poor and
enhance both their productive and human capital by generating
self-employment.

o  	The long-run cost-effectiveness of micro loans depends on the overall
growth of the economy.

o  	Bangladesh is one of the few countries in which micro loan programs
have been successfully replicated.

o  	Microfinance in the Bangladesh programs reduced poverty by increasing
per capita consumption among program participants and their families;
poverty reduction estimates based on consumption impacts show that about 5
percent of program participants can lift their families out of poverty
each year through microfinance.

o  	One percent of rural households in Bangladesh can free themselves from
poverty each year through micro loans.

o  	Participation in micro loan programs enhanced women's productive means
by increasing their access to cash income from market-oriented activities
and by increasing their ownership of nonland assets.

o  	Subsidies in the Bangladesh programs studied were necessary to defray
an array of high costs associated with providing microloans to the poor.

o  	In replicating microfinance programs, it is necessary to design a
socially conscious and transparent system of accountability that works for
both program officials and borrowers.

o  	The poor and women need special banking, so the commercialization of
micro loans should not divert attention from meeting this special need.

Appendix III: Review of Microenterprise Studies

6 	Matin, Imran; Hulme,  o  Poor people must and do save in order to
finance the  o  A shift away from credit for David; Rutherford, Stuart.
large lump sum payments needed to deal with an array of business
development toward Finance for the Poor: life- and environment-based needs
and crises. financial services of all types for the

from Microcredit to  o  The poor are a heterogeneous group of vulnerable
poor will help them to effectively Microfinancial Services. households
with complex livelihoods and varied needs. manage the many risks and
crises

2002. Journal of  o  The success of the group lending model globally is
mixed. that emerge in their lives.

International Development  o  Weekly frequency of repayment and repayment

14 (2): 273-94.	incentives (typically larger repeat loans) correlate
strongly with success, defined in terms of arrears rate and subsidy
repayment index.

7 Mayoux, Linda.

From Access to Empowerment: Widening the Debate on Gender and Sustainable
Micro-Finance.

2000. Journal fur Entwicklungspolitik 16 (3): 247-273.

8 	Mead, Donald C; Liedholm, Carl.

The Dynamics of Micro and Small Enterprises in Developing Countries.

1998. World Development 26 (1): 61-74.

o  	Some policies introduced for financial sustainability result in
adverse impacts on empowerment.

o  	Beneficial impacts of microfinance per se on women cannot be assumed;
impacts vary substantially across cases and programs.

o  	Microfinance services have enabled some, but not all, women to
increase their incomes and negotiate improvements in their family and
community position; microfinance alone is the most limited for the poorest
and most disadvantaged women.

o  	Women's decisions about loan use involve assessments of benefits,
costs, and risks in the context of the gender norms of household resource
allocation and decisionmaking.

o  	Women's choices about activity and ability to increase income are
constrained by gender inequality; market, resource, and skill constraints;
and microfinance delivery.

o  	House-to-house baseline surveys make clear that the number of micro
and small enterprises (MSE) is far larger than that reported in most
official statistics.

o  	In most countries, the majority of MSEs operate in rural areas, are
engaged in the trade and manufacturing sectors, are owned and operated by
women, and are more likely to be operated from the home.

o  	Younger, smaller, male-headed manufacturing and services MSEs in urban
areas are more likely to grow than are older, larger, female-headed trade
MSEs in rural areas.

o  	When the economy is more buoyant, new jobs come from the expansion of
existing firms; in times of stagnation, existing MSEs cut back on
employment and a larger percentage of new jobs comes from start-ups.

o  	An empowering gender policy should include increasing women's incomes
from their own activities; control of income from loans and activities;
negotiated improvements in household well-being, and access to support
networks.

o  	A gender policy that supports financial sustainability and empowerment
should consider improving the conditions of service delivery, reducing
costs of complementary services (e.g., training, gender
awareness/support), and mainstreaming gender policy.

o  	Policies and projects for supporting MSE development must be aware of
the diversity of MSEs and focus on the types of enterprises and on the
stages in the enterprise's life cycle where interventions can do the most
good.

Appendix III: Review of Microenterprise Studies

9 Morduch, Jonathan.

The Microfinance Promise.

1999. Journal of Economic Literature (37)

4: 1569-1614.

10 Morduch, Jonathan.

The Microfinance Schism.

2000, World Development 28 (4): 617-629.

o  	There are few reliable studies of the net poverty impacts of
microfinance programs; those which do exist suggest some limited positive
impacts, as well as other mixed results.

o  	Sustainable microfinance programs have by and large not been able to
reach the very poor in large proportions or numbers.

o  	Microcredit supplements clients' income and does not produce
fundamental shifts in clients' employment patterns; microcredit rarely
generate new jobs for others.

o  	The features of microfinance program designs vary to a high degree
globally.

o  	Incentives and specific program design elements such as group lending,
weekly repayments, graduated repayment schedules, and forced savings, have
been important in the successes that microfinance programs have achieved
to date.

o  	Microcredit has had very limited success in regions with low
population densities and with seasonal income patterns.

o  	There is a strong consensus among prominent policy making
organizations that microfinance institutions (MFI) that focus on
profitability (through high interest rates) will have the strongest
effects on poverty.

o  	This consensus on best practices is at odds with actual practice,
where the large majority of MFIs are not focused on profitability, have
not given up subsidies, and are not sustainable.

o  	Moderate subsidies have been necessary in some programs to attain
social objectives not present in forprofit MFIs.

o  	Efficient operations and clear incentive structures for clients and
loan staff are more important factors in achieving success in microfinance
than a focus on profitability; nonprofit, subsidized programs have been
able to operate efficiently, provided they adhere to clear budgeting and
performance criteria.

o  	Governments have played critical indirect roles in cases such as
Indonesia's BRI and Thailand's BAAC, which are state-owned commercial
banks.

o  	Savings programs will strongly complement the credit-driven approach
that has dominated microfinance to date.

o  	To alleviate poverty, new approaches to management structures and
product/program design are necessary.

o  	A diverse array of socially oriented, subsidized, and profit-oriented,
sustainable microfinance institutions is best for the microfinance
industry and for widescale poverty alleviation.

o  	If subsidized programs are to continue at current funding levels, they
will likely need to rely increasingly on their own governments.

Appendix III: Review of Microenterprise Studies

11 	Navajas, Sergio; Schreiner, Mark; Meyer, Richard; Gonzalez-Vega,
Claudio; Rodriquez-Meza, Jorge.

Microcredit and the Poorest of the Poor: Theory and Evidence from Bolivia.

2000. World Development 28 (2): 333-346.

12 Rankin, Katherine N.

Social Capital, Microfinance, and the Politics of Development.

2002. Feminist Economics 8 (1): 1-24

o  	In a study in La Paz, Bolivia microfinance lenders tended to serve
those near the poverty line, not the "poorest of the poor."

o  	Rural and group lenders tended to serve larger numbers of poorer
clients than urban and individual lenders.

o  	In addition to depth, defined as the degree to which an MFI reaches
the very poor, factors such as worth, cost, breadth, length, and scope are
important in evaluating outreach to and the social welfare of the poor.

o  	Length of outreach (time frame in which an organization produces
loans) is the key aspect of outreach because it prompts improvements in
the five other aspects.

o  	There is substantial evidence that microfinance and micro loan
programs have served to strengthen existing patterns of male and
class-based power relations, rather than empowering women.

o  	Policy-makers and MFIs should consider all aspects of outreach in
making judgments about the focus and social benefits of microfinance.

o  	Development agencies and policy should place greater emphasis on
finding ways to empower the poor and disadvantaged so that they can
overtly challenge dominant social power relations.

13 Rhyne, Elisabeth.

Microfinance Institutions in Competitive Conditions.

2002. In The Commercialization of Microfinance: Balancing Business and
Development, edited by Elisabeth Rhyne and Deborah Drake. Kumarian Press.

14 Robinson, Marguerite S.

The Microfinance Revolution: Sustainable Finance for the Poor (Chapters 1
and 2).

2001. Washington, D.C.: The World Bank.

o  	The microfinance industry has to date primarily been a one-product
industry, based on short-term (3 to l2 months) group-based lending, with
frequent repayments, and small loan sizes.

o  	Microfinance institutions have traditionally taken an inward-looking
approach to their development, focusing primarily on streamlining
operations to achieve greater outreach.

o  	In some countries, there has been a substantial increase in
competition among MFIs for clients, e.g., Bolivia, Bangladesh, Nicaragua,
and Uganda, which has increased the need for MFIs to be more oriented
toward their 1) competition and 2) clients.

o  	Overlending is a key problem that arises in competitive markets.

o  	Sustainable microfinance only occurs in systems providing commercial
financial intermediation; other models (e.g., subsidized credit) are not
sustainable in the long term and are not affordable on a global scale.

o  	Only institutional commercial microfinance can provide sustainable
financial services to the working poor by providing low-cost credit and
wide outreach.

o  	The lowest levels of the poor need food, employment, and/or government
or donor assistance and grants.

o  	Maintaining sustainability, while becoming more attuned to the needs
of clients, is critical; MFIs must adapt to the changing needs of clients
to survive and develop in the newly competitive microfinance environment.

o  	MFIs must be attuned to the problem of overlending.

o  	The shift away from donor-assisted credit delivery to sustainable
financial institutions that provide commercial microfinance is essential
to meet the global demands for microfinance.

o  	Governments must support commercial microfinance through regulation,
supervision, and public education to ensure success.

Appendix III: Review of Microenterprise Studies

15 	Rutherford, Stuart.  o  The poor can save, do save, and want to save
money;  o  The key to microfinance is to find The Poor and Their the poor
have to save to make the large lump sum creative ways to collect small
sums Money. payments that come up frequently in their lives. (savings,
repayments, insurance

2000. New Delhi, India:  o  The argument about whether the poor need
savings or premiums) and turn them into large Oxford University Press.
loans is false; they need both. sums (loans, withdrawals from

o  	Financial services for the poor help them trade their savings, or
insurance pay-outs). savings for lump sums of cash; good financial
services for the poor are those that perform this trade well.

16 	Schreiner, Mark.  o  There are six interacting dimensions of outreach:
worth to  o  Microfinance institutions should Aspects of Outreach: A
clients, cost to clients, depth, breadth, scope, and length. focus on
sustainability because the

Framework for  o  Tradeoffs exist in achieving outreach: programs focusing
longer an MFI is in operation the
Discussion of the Social on sustainability achieve breadth, length, and
scope at greater the number of clients and
Benefits of the expense of depth; programs focused on poverty the greater
the overall impact on
Microfinance. alleviation achieve depth at the expense of breadth,
poverty.
2002. Journal of length, and scope.

International Development
14 (5): 591-603.

17 	Sebstad, Jennefer; Cohen, Monique.

Microfinance, Risk Management, and Poverty.

2000. AIMS. U.S. Agency for International Development.

o  	Microfinance programs have been more successful in reaching clients
from moderately poor and vulnerable non-poor households than from
extremely poor households.

o  	Clients use loans for a wide range of purposes beyond enterprise
development.

o  	Micro loans are more useful for clients in protecting against risks
ahead of time than in smoothing consumption following a shock.

o  	Investment in productive assets is more prevalent among clients having
larger loan sizes, higher numbers of loans, and more time in the program.

o  	Microloans have positive impacts on reducing vulnerability measured as
diversified income sources, increased numbers and types of assets, and
women's empowerment.

o  	Future programs should link services to clients' needs and demands,
should become more flexible, and should diversify services offered.

o  	Linking financial services with other supportive services could
improve clients' ability to deal with risks.

                Appendix III: Review of Microenterprise Studies

18 	Snodgrass, Donald R.; Sebstad, Jennefer.

Clients in Context: The Impacts of Microfinance in Three Countries.
Synthesis Report

2002. AIMS. U.S. Agency for International Development.

o  	Overall, microfinance makes a difference to people's lives; however,
microfinance does not have the unequivocally large, positive impact on
microenterprise development and poverty reduction that has been claimed
for it by some.

o  	Microfinance impact is a function of product characteristics, the
macroeconomic situation, and the length of time the client has been in the
program.

o  	The microfinance programs reviewed had significant impact on a variety
of individual-, household-, and enterprise-level income and well-being
indicators, although the nature and magnitude of these impacts vary across
countries and programs.

o  	Microfinance provided recipients with resources for dealing with risks
typically not available to nonrecipients.

o  	Receiving a micro-loan resulted in greater household and enterprise
decision-making authority for women in the study.

o  	Expanding and diversifying services to include savings, insurance, and
emergency loans will increase impact and enhance clients' ability to cope
with shocks.

19 	Snow, Douglas R; Buss,  o  We have very scant knowledge of the
relationships  o  Governments, if not all donors, Terry F. between program
designs and outcomes. ought to have specific goals for

Development and the  o  There have been very few strong microfinance
program micro loan programs and these Role of Microcredit. outcomes
studies; as a consequence, "there is good should be grounded in strong
reason to fear reliance on program design as a surrogate research and
knowledge of 2001. Policy Studies for outcomes." impacts.

Journal 29 (2): 296-307.

o  	If forced to stand alone, few micro loan programs, if any, would
survive.

o  	The twin concepts of sustainability and outreach are inherently
contradictory.

20 Von Pischke, J.D.

Current Foundations of Microfinance Best Practices in Non-Industrialized
Countries.

2001. In Replicating Microfinance in the United States, edited by Jim Carr
and Zhong Yi Tong. Washington, D.C.: Fannie Mae Foundation.

o  	Major players in both sustainability- and poverty-oriented MFIs have
developed a consensus about preferred microfinance strategies.

o  They have generally agreed upon 12 best practices:

                                     o   o

                                     o   o

                                     o   o

o

o   o   o   o   o

Create sustainable institutions.

Charge interest rates that will enable the lender to cover costs.

Control arrears.

Use subsidies for institution building, i.e., technical assistance and
capitalization.

Behave competitively from the outset.

Maintain uncompromising commitment to the target group.

Select "owners" who will provide effective governance.

Manage risk, explore failure.

Develop good management information systems.

Be transparent.

Focus on incentives.

Exchange information on defaulters.

Appendix III: Review of Microenterprise Studies

21 	Woller, Gary M.; Dunford, Christopher; Woodworth, Warner.

Where to Microfinance?

1999. International Journal of Economic Development 1 (1): 29-64.

o  	There is general agreement in microfinance that poverty reduction and
the achievement of financial self-sufficiency are the basic goals for the
industry.

o  	The industry disagrees on how to achieve these goals: the
institutionists emphasize financial self-sufficiency over a focus on the
very poor; the welfarists emphasize assisting the very poor over the need
for financial selfsufficiency.

o  	The institutionist perspective has become more prominent in the
microfinance industry, but its assertions that subsidized institutions
cannot survive for long periods and cannot have strong, large-scale
impacts on the very poor are not fully supported by existing evidence and
are based on an array of questionable or inconsistent assumptions.

o  	Most microfinance institutions lie somewhere along a continuum ranging
from traditional business and traditional social service orientation.

o  	There is no need for a once-andfor-all choice between competing
approaches; the microfinance industry should be characterized by a
diversity of microfinance institutions that cater to various segments of
low-income communities.

22 Wright, Graham.  o  Replication of a best practices model for
microfinance  o  To be successful, microfinance program design has been
difficult, because the contexts programs must be adapted andReplication.
Regressive in which such a model would be implemented vary so tailored to
the cultural, economic,Reproduction or Progressive Evolution? greatly.
social, and political features of the

2000. Journal of  o  Institutions attempting to replicate the same general
contexts in which they are microfinance model are characterized by a high
level of implemented. Microfinance 2 (2): 61-81. diversity in
implementation methodologies.  o  Implementation and replication of

o  The poor often participate in a variety of formal and programs must
include a period of

informal financial institutions. research, experimentation, and
adaptation.

Appendix IV: USAID's Microenterprise Results Reporting

To monitor and evaluate its microenterprise portfolios, USAID developed a
data collection process and information management system known as the
Microenterprise Results Reporting (MRR). The term also refers to an annual
report that presents the agency's financial data-primarily amounts it
obligates for microenterprise development-and programmatic information.

The MRR data are collected through annual surveys of USAID staff in
headquarters and at overseas missions and the institutions that receive
USAID funding. A USAID contractor is responsible for data collection and
the management information system. Beginning early in each fiscal year,
the contractor requests obligations data for microenterprise projects from
USAID headquarters and missions. The mission staff report current year
obligations and identify the recipient institutions, categorizing them as
microfinance, business development services (BDS), or policy services
providers. In addition, the mission staff identify institutions that
received obligations in previous years for ongoing projects.

Separate surveys have been designed for the microfinance institutions
(MFI), BDS providers, and policy service providers. The survey for MFIs
asks about outstanding loan balances, the number of loans to women,
maximum loan sizes, loan loss, loans below the poverty lending threshold
percentage, the number of rural clients, savings, and the financial
sustainability of the institutions. The survey for BDS providers asks
about the types of services provided, the number of clients overall, the
number of women clients, the number of rural clients, the number of
clients with "poverty loans," data sources for clients, the clients'
industrial sector, the institutions' competitors, the demand for BDS, and
exit strategies. The policy service providers survey asks about the types
of institutions and for descriptions of policy issues covered.

The number of respondents to the annual surveys during 1998 to 2001 has
remained fairly constant, ranging from 361 to 411. Most MRR respondents
complete the MFI survey. In 2000, for example, 512 surveys were sent out;
282 of the 361 respondents completed the MFI survey, 99 completed the BDS
survey, and 18 completed the policy survey. The reported response rates
rose in recent years, from 56 percent (411 surveys) in 1998 to 84 percent
(492 surveys) in 2001.

USAID contractor staff analyze the data and, in some cases, apply
methodologies the agency has developed to assess whether it has met
particular program goals, such as its poverty-lending target. This

Appendix IV: USAID's Microenterprise Results Reporting

methodology is designed to weight the individual institutions' obligations
by the amounts of loans that are considered poverty loans.

The data and the analyses are presented in the annual reports, which also
provide examples of USAID-funded microenterprise projects. In addition to
publishing the data in the MRR reports, the contractor also publishes
selected data on a Web site accessible to the agency's missions,
institutions that receive USAID-funding, and interested others.

Note: GAO comments supplementing those in the report text appear at the
end of this appendix.

See comment 1.

                 Page 54 GAO-04-171 Microenterprise Development

                                 See comment 2.

                                 See comment 3.

                                 See comment 4.

                 Page 55 GAO-04-171 Microenterprise Development

                 Page 56 GAO-04-171 Microenterprise Development

                 Page 57 GAO-04-171 Microenterprise Development

                                 See comment 5.

                 Page 58 GAO-04-171 Microenterprise Development

                                 See comment 6.

                                 See comment 7.

                 Page 59 GAO-04-171 Microenterprise Development

                                 See comment 8.

                                 See comment 9.

                 Page 60 GAO-04-171 Microenterprise Development

                                See comment 10.

                                 See comment 4.

                 Page 61 GAO-04-171 Microenterprise Development

                 Page 62 GAO-04-171 Microenterprise Development

                                See comment 11.

                                See comment 12.

                 Page 63 GAO-04-171 Microenterprise Development

                 Page 64 GAO-04-171 Microenterprise Development

    Appendix V: Comments from the U.S. Agency for International Development

  GAO Comments

The following are GAO's comments on USAID's letter dated November 6, 2003.

1. 	USAID stated that our report does not address the full range and scope
of its microenterprise strategy and program. Our report focuses primarily
on microfinance, since this component of USAID's microenterprise program
has received, and continues to receive, the bulk of the agency's funding.
Microfinance has also been the principal focus of long-term studies funded
by USAID and others. We found no long-term studies or evaluations that
assessed the impact of USAID's support for Business Development Services
(BDS) or its policy work in the area of microenterprise development. Our
discussions with USAID employees in Peru, Egypt, and Bulgaria regarding
BDS and policy initiatives yielded some information on these efforts, but
we found that no data on these efforts had been collected systematically.

2. 	USAID said that it has long used loan size as a proxy for services to
the very poor, recognizing that it is imperfect but a statutory
requirement. Because of the limitation of loan size as a proxy, we
analyzed impact studies and evaluations funded by USAID and others that
collected information on borrowers' economic status to determine the
extent to which microfinance has reached the very poor. These studies,
based on in-depth research across multiple countries and settings, found
that the very poor are rarely reached with micro loans, for reasons
outlined in this report (see app. III for a summary of key studies on this
topic). To complement information contained in these studies, we discussed
this issue at two roundtable meetings with international experts; we also
interviewed USAID officials and nongovernmental organization officials
working with USAID-funded programs in the countries where we conducted
fieldwork. The consensus across the literature and among the experts is
that microfinance projects often have difficulty reaching the very poor.

3. 	USAID said that the MRR has used a single, clear definition of
sustainability in questionnaires to implementing partners. We disagree
with USAID on this point, and we have added information to this section to
clarify our concern regarding the agency's lack of a standardized method
for measuring microfinance institutions' (MFI) sustainability. As noted in
the report, 38 percent of MFIs that received USAID funding in fiscal year
2001 reported that they had achieved financial sustainability. In
addition, the figures cited in USAID's response combine data on
operational and financial sustainability, despite the fact that
operational sustainability is defined in USAID's

Appendix V: Comments from the U.S. Agency for International Development

policy guidance as an interim measure toward the goal of achieving full
financial sustainability.

4. 	USAID stated that allocating the impact between USAID and other donors
would be impractical and methodologically questionable. However, it also
says that it plans to include language in its annual report indicating
that many of USAID's awardees receive support from other sources as well,
and that these sources deserve a share of the credit for the awardees'
impacts.

5. 	See comment 2. USAID states that it made about 2 million loans in
fiscal year 2001 that met the statutory standard for service to the very
poor. The agency said that it also utilized other methods of reaching this
group. As noted in the report, Congress recognized the limitations of loan
size as an indicator for targeting and reaching the very poor and directed
USAID to develop more accurate methods to ensure that this group is
reached in the future.

6. 	USAID said that the report suggests that loans to the very poor can
have negative consequences and may be a significant or widespread problem.
As noted in the report, the very poor can benefit from credit, but some
evidence suggests that microcredit should compliment, not substitute, for
investments in core services, such as health and education.

7. 	USAID states that their record of supporting MFIs and achieving
sustainability is strong. With regard to the issue of MFIs' achieving full
financial or operational sustainability, we note in the report that
USAID's policy establishes full financial sustainability as its goal; that
is, to develop fully financially sustainable MFIs, capable of providing
services indefinitely without USAID or other donor support. We did not
report data on operational sustainability because this measure is defined
in USAID's policy manual as a "useful interim standard of financial
performance." Accordingly, we focused on full sustainability, a standard
that, if widely attained, could ensure that these institutions would be
available to provide these services in the future. Also, see comment 3.

8. 	USAID said the report suggests that sustainability might not be
consistent with serving very poor clients. Our report does not state or
suggest that sustainability might not be consistent with serving very poor
clients. We agree with USAID that attaining full financial sustainability
may be more difficult for MFIs serving greater numbers of very poor
borrowers.

Appendix V: Comments from the U.S. Agency for International Development

9. 	USAID incorrectly attributed to us an audit conducted in Egypt; this
audit was conducted by the USAID Inspector General.

10. USAID stated that its policy allows microenterprise funds to be
obligated for activities that do not meet the definition of
microenterprise development found in the MRR and that microenterprise
awardees do not have to solely serve micro-scale enterprises. However, our
report addresses the reporting of such activities, not the policy.
According to the 2001 MRR, "Microenterprises are small, often informally
organized businesses that are owned and operated by poor and very poor
entrepreneurs. USAID defines a microenterprise as one that comprises 10 or
fewer employees, including unpaid family workers, in which the
owner/operator of the enterprise...is considered poor. By limiting its
definition of microenterprises to those whose owners/operators are poor,
USAID ensures that the focus of its efforts remains on the most vulnerable
households in higher-risk environments." Despite this definition, the
annual MRR reports present data on a wide variety of activities that do
not meet this definition. This includes its policy work, much of its BDS
work, its obligations to small and medium businesses, and loans to those
that are not poor. As a result, it is uncertain how much of USAID's
funding is going to poor microenterpreneurs. We believe that USAID should
be more transparent in reporting these results.

In addition, despite USAID's statement that the MFIs and missions report
only activities that meet the definitions of microenterprise as defined in
the MRR, we found no evidence of this in our work in three countries or
our analysis of MRR data. As noted in this report, we found numerous
examples of the missions' and implementing partners' reporting activities
to the MRR that did not meet the MRR definition. Based on USAID's
comments, we have modified this section of the report to further clarify
our position and the basis for these observations. USAID also said it will
include more explicit guidance on its website to address the issue. This
could potentially improve this aspect of USAID's reporting.

11. USAID stated that the report focused on a narrow definition of program
impacts. This report does not take a narrow view of the impacts of USAID's
microenterprise program. In addition to our assessment of its impact on
poverty alleviation and poverty reduction, there are sections focused on
reaching the poor and very poor and other services these groups may need;
outreach to women; the sustainability of MFIs; the reliability of the MRR;
best practices

Appendix V: Comments from the U.S. Agency for International Development

identified by the microenterprise development industry; USAID's efforts to
identify and promote best practices; whether USAID incorporates best
practices in their projects; and a synopsis of 22 key studies. In both the
body of the report and appendix III, we include considerable discussion of
the extent to which microfinance can help alleviate poverty by reducing
risk and vulnerability.

12. USAID states that microenterprise development can be a successful
intervention to shift from humanitarian to development assistance
following conflicts and natural disasters. The USAID policy manual
(section II.H.4.), titled "Avoiding Poor Prospects for Microfinance
Development," states that microfinance should not be viewed as a response
to alleviate the large-scale human suffering created by wars and civil
conflict. It notes that such assistance will inevitably conflict with the
basic requirements of building sound financial institutions. Despite this
guidance, we found that USAID/Bulgaria used emergency funds provided for
the Danube River Initiative to respond to the economic hardship resulting
from the Kosovo crisis, providing funding to MFIs that committed to work
in this region. Officials of the implementing partner told us that this
humanitarian initiative, while important from a social perspective, proved
to be financially unsustainable in light of the many challenges refugees
faced. Accordingly, the implementing partner terminated its programs in
these regions, according to USAID officials in Bulgaria.

Appendix VI: GAO Contact and Staff Acknowledgments

GAO Contact

  Staff Acknowledgments

(320170)

Phillip Herr (202) 512-8509

In addition to the person listed above, Edward George, Jim Strus, Martin
De Alteriis, Mona Sehgal, David Dornisch, Yesook Merrill, Valerie
Caracelli, and Reid Lowe made key contributions to this report.

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