The making of microfinance - six steps to significant change

We need a new sustainable mainstream and we need it fast. So change agents need to get smarter about how to create change. Through a series of articles I am going to look at some successful examples of change and explore what they tell us about how to be more effective for sustainability. I will use Forum's six steps to significant change to frame this exploration – a model based on change theory and practical experience.

To introduce the model, what better place to start than the poster child of new business models for the poor, Grameen Bank and microfinance.

Microfinance is the supply of loans, savings and other financial services to the poor. The focus is often on microcredit – providing small loans for people without collateral to start a small business – to buy a sewing machine for example.

The Grameen Bank is one of the first microfinance institutions. Its story starts in the 1970s when Muhammad Yunus, Grameen's founder, returned to Bangladesh from the US. As head of economics at Chittagong University, he was struck by the disconnect between his teaching and the world around him. He had reached the first of our six steps; understanding the need for change.

His frustration drove him to a nearby village to find out what was actually happening. Through action research, he found a group of women who were stuck in the poverty trap even though they had a trade. Yunus tells a story of Sulfiya who made bamboo stools. In the morning she would buy bamboo through a loan from a money lender and then sell the stools back to him in the afternoon. He would charge interest on that loan leaving her with only two cents profit. Sulfiya stayed poor because she lacked access to affordable credit.

Yunus had diagnosed the system; step two of the change curve. He had put his finger on the real problem: because the poor had no collateral to secure loans, little or no credit histories, and generally wanted to borrow less than viable amounts for banks, they were locked out of the credit market. The challenge was to provide small loans at a low enough administrative cost to get a return and ensure that as many people as possible paid the money back.

Experimentation and innovation follows on from the problem diagnosis – we call this creating pioneering practice. Yunus experimented until he came up with a more structured funding model. One of the major innovations of the Grameen Bank was group borrowing, predominantly by women. The bank asks borrowers to form a group of five people, who are lent money on the proviso that the whole group make the repayments. Given repayment rates of 97%, this use of peer pressure has clearly been successful in reducing credit risk. Grameen Bank has now leant around $10.5bn (£6.4bn) to over 8 million borrowers, and made a profit in all but three years of its existence.

The next step in creating change is enabling the tipping point. Tipping points can happen at an organisational level – the Grameen Bank substantially growing its business for example – and at a more global level when similar approaches being used in different countries become mainstream.

Networks and communications are critical. Yunus was excellent at communicating, publishing the approach as he went along to academics who then disseminated it further. At the same time organisations like the Microfinance Information Exchange (Mix) create a strong network by bringing together the different initiatives happening globally, sharing their success and lessons learned. Mix estimates that Grameen is now just one of a couple of thousand other microfinance institutions (MFIs) serving 68 million clients in five continents. Quite a movement.

The final two stages of the change curve – sustaining the transition and setting new rules for the mainstream – are about maintaining the change that has been created, often through governance structures, voluntary commitments, new consumer standards or regulation.

Microfinance has now reached an interesting stage in its development. It is becoming integrated into the mainstream financial infrastructure with many banks getting involved. In 2007, rating agency Standard & Poors released their first rating system for MFIs. These sorts of structures help build confidence in a new approach for mainstream investors. They also help buffer against the inevitable criticisms that come at this stage (something that change agents underestimate). developmental and financial perspective. Yunus himself has been controversially removed from Grameen, with the Bangladesh Government taking greater control. This points to the need for strong institutions, and in some cases regulation, for microfinance to ensure universal standards and to defend and improve its contributions to poverty reduction.

The Microfinance story is clearly not over yet (although it seems that Yunus' time at the bank has), but there is a lot of learning in it that will help others to emulate its success. This introduction may seem simplistic, but the six steps for significant change can help us to be more deliberative about how we intervene to promote sustainable development. In a couple of weeks we'll look at what we can take from Edison's light bulb moment.

This blog was originally published in Guardian Sustainable Business on May 19 2011. Click here to read the blog in The Guardian Sustainable Business.