The "Combined Loan Problem": An Unexpected Twist from a Wrong Assumption

I recently discussed a product-environment mismatch in my first venture into housing microfinance. In our second season of operating that home improvement loan (HIL) in rural northern Malawi, we had a fascinating development that was the direct result of the product-environment mismatch and some wrong assumptions made as we developed the product. It was frustrating as a program manager, but at the same time I couldn’t help but to admire the creativity of our clients in addressing their housing needs as experienced in the local context.

In the first season of our HIL program (May to December 2002), the maximum loan amount was 12,000 kwacha (or approximately $200 at the time). This was enough to roof a small, simple house. It was assumed that if clients had a larger houses, they could roof part of the house with one loan and roof the rest of the house with a subsequent loan. Examples of houses that were partially roofed with thatch and partially roofed with corrugated metal sheets had been viewed in various places around the country during our market research. At the close of the season, an evaluation was held and people in the community almost universally stated that the maximum loan size was too small. The majority of respondents recommended that it be raised to 18,000 kwacha. This seemed reasonable and the HIL product was adjusted to have a maximum loan amount of 18,000 for the following season.

With the harvest and the start of the next season in May 2003, community members were pleased that we had listened to them and adopted many of the changes they had recommended. Unfortunately, by that time the economic situation had changed. 18,000 kwacha in May 2003 bought fewer roofing sheets than 12,000 kwacha had purchased in May 2002! We definitely were not keeping up with the pace of change in the economy, so some creative clients decided to take matters into their own hands. They essentially created something like a ROSCA (Rotating Savings and Credit Association) using our home improvement loans.

Let me take a brief moment to explain how a ROSCA works. A ROSCA is an informal finance mechanism that is very common in Africa. In West Africa is called susu, in Congo it is called likelembe, in Tanzania it’s upatu and it is known by many other names across the continent. The most common form of a ROSCA brings together a group people who trust each other and decide to give a fixed amount of money to the group at given intervals over a period of time. They take turns receiving the entire amount until each person has received a payout. This helps the ROSCA members take small earnings and convert them into a larger more useful amount. For some excellent reading on how the poor convert small amounts of income into larger and more useful sums, Stuart Rutherford’s The Poor and Their Money is highly recommended and can easily be located through an internet search and downloaded.

An example of a ROSCA might be a group of 7 people who decide to pay 500 shillings (an East African Currency) each to the group per day over a period of one week. Each day, a different person in the group takes home the total amount of 3,500 shillings (3,000 shillings from friends and their own 500 shillings). The first person in the group to receive the payout received 3,000 shillings credit from the group, which was repaid over the rest of the week. The last person to receive the payout essentially saved 3,000 with the group and got it back on the last day. At the end of a rotation, the group can continue, disband or reform with new members and/or terms.

To continue to digress with a practical example of a ROSCA, one of my very early assignments was in appropriate technology transfer and making roofing tiles. In one “factory” with which I worked, there were six young tile workers who were unmarried and still lived at home. Their salaries were primarily used for frivolous consumption. They realized, however, that the cost of a new bicycle (not just any bicycle, but the coveted Phoenix bicycle) was almost exactly six times their salary. They made a pact and formed a ROSCA. For six months, they all gave their entire salaries to one of the tile workers, who bought a bicycle. At the end of six months, they each had a Phoenix bicycle, improved transport and a certain level of local prestige. They then disbanded their ROSCA and went back to their normal spending patterns.

And now back to the home improvement loan clients in northern Malawi... Because the maximum loan size was too small to roof some of the clients’ houses, extended family members and close friends formed groups of three. (These were informal groups and completely unknown to us at the time that the loans were disbursed.) Each group member applied for a maximum home improvement loan to roof his own house. When the loans were disbursed, however, two of the clients would give their loans to the third client, who would completely roof his house with the three loans. When the loans were paid off, they planned to do the same thing again and roof another house. This was a brilliant client adaptation. Unfortunately, where we thought we would report three houses roofed with home improvement loans, the loans had only roofed one house. We called it: “The combined loan problem.”

A "COMBINED LOAN" HOUSE

The clients didn’t seem to think the combined loan problem was a problem at all. As far as they were concerned, it was none of our business whether they actually roofed the house they had told us they would roof or whether they had decided to help a friend instead, as long as they paid. It was hard not to see their point, although it was contrary to our systems and our objective of each loan resulting in a home improvement on the house of the client. We continued to make product adjustments to avoid the problem in the future, but we realized that we had made a critical wrong assumption in our product design process.

We had assumed that if the maximum loan amount was not enough to roof an entire house, people would roof part of a house. We had seen this in Malawi, but not in that specific area in which we implemented HIL. As we delved deeper, we found that in the local culture “No Ngoni (the predominant local tribe) man can partially roof his house.” Out of the few people who met our construction quality criteria for a loan (see 19th September posting), many did not come forward for the loan because it could not roof their whole house. In their personal assessment of our product’s usefulness for their housing situation, it was better not to roof their house than to partially roof it. “What made me not pay the deposit (to receive a loan) is that I was not yet decided on having my house partly roofed or not. I had to think twice on this,” said one registered client who had not applied for a loan. “I didn’t apply last year because I wanted a complete roof for my house. By the time we were answered that we could get a double loan (meaning by the time he found out others were combining loans), it was already raining and I was focused on other things,” said another person, who also alludes to the impact of seasonality on the calendar of local activities. The unsuitability of a partially roofed house was a common theme that came up in the season two evaluation, as we continued to learn and better adapt our home improvement loan product to the housing realities of the people who would use it.

A lesson learned from the combined loan problem was that market research should be specific for the area in which the product is being launched. At the very least, generalizations and assumptions taken from the broader context should be verified in the local context. Another lesson learned was that using a learning cycle of research – design – implementation – evaluation – redesign – implementation – evaluation, etc. is very helpful when launching a new product or using a new approach. The home improvement loan product changed significantly from the way it came “out of the box” from product development, as we have learned from how it was used (or not used) and how clients and potential clients viewed it. Market research is great and necessary, but further evaluation and research based on actual implementation sometimes tells more.

(Photos and chart used in this posting are by the author)

A Product-Environment Mismatch?

My first venture into housing microfinance was in rural, northern Malawi in 2001-2005. Up until that time, years of building standard house designs and defining the housing process had produced a lot of houses, but repayment rates were very poor, (even with a high level of subsidization). Our first attempt to break out of the “provider” paradigm of housing was to use a building in stages model. We would build a small unit first, which could be extended with subsequent loans after each stage was paid off. The theory behind it was that it would keep costs low while giving the client incentive to pay so as to extend the house. This is what I labeled as “provider controlled incremental building” in a previous post. It had some level of success, but did not achieve as much as hoped. Demand was limited.

Houses like the one above were dramatic improvements over traditional houses in terms of construction standards and popular with donors, but loan performance was extremely poor even with very soft terms. To attempt to improve loan performance, a 3-stage "building in stages" design was introduced.

A "BUILDNG IN STAGES" STAGE 3 HOUSE

After conducting research on housing across all three regions of the country, we decided to pilot a home improvement loan product. We selected an area that had relatively high density compared other rural areas and one in which there was both evidence of economic activity as well as housing need. The vast majority of houses in the area had compacted earth floors, grass thatched roofs and mud walls. The population expressed a positive attitude towards improving homes when interviewed, although hidden underneath there were some unspoken cultural beliefs that dissuaded people from improving their homes to a level that might be better than their neighbors.

TYPICAL HOUSES IN NORTHERN MALAWI, CONSTRUCTED OF MUD OR MUD AND POLES

Our home improvement loan product was very much influenced by our organization’s operating policies and institutional culture at the time. Instead of interest, the loans were adjusted for inflation using a commodity-based index and the loans were disbursed in-kind in the form of materials. The most significant breaks from our past were that 1) the loan would not result in a “completed” unit, 2) the loan went to a structure as designed by the client, 3) we did not do or supervise the construction work, 4) the loan amounts were smaller with a shorter loan period. The initial program essentially was rolled out as several different home improvement loan products with slightly different terms: a roofing loan, floor loan, latrine loan and a loan for doors and window. There was also an option to buy plastic sheeting as a sort of lay-away product for those who could not afford a home improvement loan. (Because of scarcity of grass for thatching, most roofs were poorly thatched and used plastic sheets underneath to waterproof the house.) The loans were disbursed and payments collected seasonally, immediately after the harvest period (dry season). This fit the income patterns and with the traditional period for working on housing.

With a few adjustments on pricing and modalities of disbursement, the home improvement loan might have been an effective product. The challenge we faced, however, was in the criteria for loan approval. There had been many debates during the product design process, and even while reviewing the product during an annual evaluation and revision process each of the first few years. One of the key debates was how to ensure quality. If we did not control the house design and construction process (other than disbursing the loan as materials), how would we ensure that the loan resulted in a quality house? Our answer was a rigorous pre-loan assessment of the structure and criteria that required the structure to be built of burnt brick, have a foundation of a certain depth and have no visible weaknesses or faults in the wall. The criteria were widely communicated throughout the target area.

A PRE-LOAN ASSESSMENT OF THE STRUCTURE

In the first season of implementation, there were not many loans disbursed. Those few that were disbursed were for the relatively wealthier. (They were not wealthy in an absolute sense by any means, but they were clearly the better off in the local context.) The problem was simple. We required that houses be built to a certain standard to receive a loan, but almost no houses complied with the standard we required. They were built with mud walls that did not have a foundation. It was very poor link between our research and the product features. Sufficient income and housing need did not equate to effective demand for our home improvement loan because our own criteria disqualified over 90% of the population! This was a product-environment mismatch that would have led to extremely poor financial performance (had we been measuring it).

Over time, people began to build in order to meet the criteria, but it was a long process. In one year they would mould and burn their bricks. The following year they would build a structure and then roof it with grass thatch. In the third year they might apply for a loan. In the end, the program may have had a positive impact on housing development in the area. It broke some cultural barriers that had been restraining people from improving their houses even though they had sufficient income to do so. The availability of housing finance seemed to have a positive effect, but in its fourth year I left to work in another country before impact could be studied. I am unaware of how it has progressed since that time.

A CLIENT, STAFF AND NEIGHBOURS IN FRONT OF A HOUSE ROOFED WITH A

HOME IMPROVEMENT LOAN

Certainly the product could be improved and made more effective, but I am not sure whether it could reach sufficient volume to make it sustainable. We were fortunate that sustainability was not an objective at the time, and we were able to subsidize the costs of a long start-up period. Microfinance institutions entering into rural housing microfinance might not have the luxury of a very slow start.

I am not yet decided whether the best approach for housing microfinance in similar rural African settings would be to loosen standards and allow loans for roofs on mud structures or to proceed in the manner in which we did in Malawi and try to increase the standard of construction by setting minimum quality standards as criteria for loan approval. I suspect that even offering loans for roofs and other improvements on mud wall structures might eventually lead to people building to with improved standards over time, but I am currently working in an urban environment and have not ventured back into rural housing microfinance yet to find out if that would hold true.

If anyone has additional experience or ideas on rural housing microfinance, I would enjoy hearing about it under comments.

All photos used taken by author

Incremental Building and Housing Microfinance Part III: The Product Fit

If it is agreed that the poor tend to build incrementally and that housing microfinance can flourish where this type of home construction is actively taking place, then successful housing microfinance products will be designed to interface with incremental building processes. Perhaps the most common housing microfinance product is some kind of home improvement loan. Although often thought of as being for repairs and renovations, home improvement loans can be applied to a variety of uses in the incremental process. I usually group home improvement loans into five loan use general categories, which are by no means exhaustive or definitive.

COMPLETION: I currently define completion as when a home improvement loan (or similar housing microfinance product) is applied to new house construction on a house that has not yet been occupied. The objective of completion is to bring a structure to the point that the dweller can occupy it, (or to work towards occupation if it cannot be achieved with a single loan). I generally consider “completion” of a structure as dweller-defined by occupation: A house is complete when the household decides to occupy it. This is unlikely to ever be accepted as an industry standard, but it comes with the caveat that a house can be complete (good enough for occupation by the dwellers’ standards and/or current needs) without being “finished.” The point at which dwellers decide to enter the home varies from household to household, depending on their individual circumstances and livelihood strategies. Some are quite willing, or find it necessary, to occupy a structure as soon as there is a roof for shelter. Others require more substantial work to be completed prior to occupation.

Completion loans bridge financing bottlenecks to make a house at least minimally habitable (according to the criteria of the dweller) and usually build upon previous in-kind savings in the form of the materials and structure of the walls. In Sub-Saharan Africa, completions commonly translate into roofing a structure and / or shutting the structure with doors and windows. Because the roof is an expensive and challenging investment for many households, loans for completion  help a household occupy their new home and continue work on it as they enjoy its shelter.

The foundations and walls of a new house would also fall under the category of completion. In the housing microfinance products which I have developed, however, we have favored working with structures that already have the foundations and walls built. This helps to ensure that the client is actively committed to his or housing process and has some stake and investment in the structure. By the time a client has constructed a house to wall plate level, he or she has much experience in the housing process and has more realistic expectations of what is ahead compared to someone who has yet to start building. I have, however, seen foundations as a housing microfinance loan or component thereof.

The house above appears to have had the wall raised in several stages and then been left for some time (tall weeds inside). It is typical of a loan used for roofing to work towards occupation.

Construction on this house appears more recent, but would also fall under the "completion" category.

The small house is ready for a completion loan (roofing, doors and windows), but the owner has plans to extend to the right in the future.

FINISHING: I consider finishing as new work undertaken on an occupied house. Housing is a process that is rarely ever truly “finished.” In How Buildings Learn: What happens after they’re built, (which is fascinated reading), Stewart Brand demonstrates that even buildings that have been “completed” and/or “finished” still often undergo significant change over the course of time. Building upon the work of Frank Duffy, Brand identifies “six S’s” that define a building and are subject to change: Site, Structure, Skin, Services, Space Plan and “Stuff.” [1] Brand’s concepts are broadly applicable and visible, even in the informal settlements and rural communities of Africa. Brand focuses on changes to a building that may have otherwise have been considered “finished” at one time, much of which would be considered extension or repair/renovation in my loan categories. Finishing as a housing microfinance loan use tends to add structure, skin and services for the first time as the dwellers occupy the house. This includes key house components such as floors, ceiling, doors and window, plaster, utility connections, etc. The finishing loan use category corresponds to an incremental building strategy of moving into a structure before it is completely finished.

The dweller-influenced loan use classification I have utilized is sometimes initially confusing to loan officers. What is classified as a completion for one household may be finishing for another, even though the actual work done is exactly the same. A common example of this is windows and doors. Some households are willing to occupy a structure before the windows (and sometimes even doors) are installed. They cover the window and door openings with some provisional solution, such as plastic, old sacks, mats, blocks, old iron sheets or just about any other  imaginable item. Other households, however, find this totally unacceptable and will not occupy a house that has temporary shutting (e.g. see picture above of roofed house lacking windows). The amount and value of household assets (stuff) at risk from theft, the likelihood that the house may be left unattended for periods of time and the security situation in the neighborhood may be some of the factors influencing thes decisions. In summary, the completion and finishing loan use categories tell whether the work was done on an unoccupied or occupied home.

Floors, plaster, ceilings, utility connections and even windows are often added to houses gradually after occupation. These activities are well suited for housing microfinance loans and can makes a significant improvement in living conditions for the household.

Windows are often details left to be finished after occupation. The houses above are examples of occupied structures with windows made of temporary materials.

EXTENSION: Extension involves adding new rooms to an existing house. Many houses are designed constructed for possible future extension. A growing family is often a cause for extension to a home. Sometimes, homes are also extended to earn income through a home-based business or rental units.

Extensions take many forms and are also often built incrementally. The houses above have begun extending incrementally, with partially completed walls in the areas being extended.

REPAIR / RENOVATION: Replacing old components of a home with newer components. Re-roofing is a common repair undertaken in older informal settlements. I also consider upgrades as being in the repair / renovation category, such as replacing older doors or windows with new ones.

Houses that could benefit from a loan for repairs. Built with sun-dried blocks, the structures are at risk due to the condition of the roofs.

AUXILIARY STRUCTURE: Adding additional structures on one’s plot. In areas where there is no sewage connection and no access to electricity, outdoor cooking, bathing and cooking are the norm. Bathing areas and even toilets are often open and sometimes only made of temporary materials such as plastic, mats or reeds. The construction of such outdoor structures can provide greater privacy and living conditions by improving sanitation on the property.

Examples of outdoor baths and latrines that could be replaced with a loan for an auxiliary structure on the client's  property.

Names for loan use categories are not necessarily important. What is most important is that a housing microfinance product is flexible and aligns with the local building realities for low income households. Flexibility allows multiple options to borrowers in their housing process. The housing microfinance program with which I am currently involved in Dar es Salaam is still very new, but the breakdown of loans by loan use category so far is approximately as follows:

Finishing:                             54%

Completion:                         22%

Repairs:                                11%

Auxiliary Structures:           9%

Extensions:                           4%

This is likely to change in the future as we gain more clients and enter into new areas. Older settlements are more likely to have finishing and repairs, while new settlements have more completions.

The loan use categories presented here are simply ways of tracking what the loan was used for and do not represent different loan products. In time, however, they may provide information that could identify a need to adjust product features for specific loan uses. Regardless, flexibility that fits into the local practice and keeps the dweller in control is likely to be a key in making a housing microfinance intervention successful in reaching large numbers of households in a sustainable manner.

[1] Brand. S. (1994) How Buildings Learn: What happens after they’re built. NY: Penguin. 13.

Increment Building and Housing Microfinance Part II: Provider Controlled Incrementalism

There are at least two very different approaches to incrementalism within housing and housing microfinance. The approach I advocated in my previous posting was to design housing microfinance products that support existing, dweller-controlled incremental building efforts. In this approach, clients are already building incrementally according to their own house designs and process. Another approach, however, is to provide clients with an incremental building design and process. I will call this “provider controlled incrementalism” and personally see it as a second-best option that has numerous drawbacks. This prescribed building in stages may, however, meet some specific housing needs and have a niche market in some areas. The challenge will be whether it can be sustainable.

In my 8th August posting on Housing Paradigms and Housing Microfinance, I mentioned that one difference between the Provider and Supporter Paradigms of housing, as described by Nabeel Hamdi in Housing Without Houses: participation, flexibility and enablement, is that providers tend to seek “instant housing” in the form of units that are completed to a given standard, while supporters tend to be more comfortable with incremental processes. The challenge for providers then becomes making “instant housing” affordable for low income households. Where heavy subsidization is not an option, providers may tend to appropriate the incremental building concept and develop incremental building designs. These building in stages designs are usually small units built to a given standard that can be extended at a later date using subsequent loans. Clients building under this method will use a provider’s design and fit into an incremental process as defined by the provider. Providers and supporters may use similar language and acknowledge that incremental building is common among the poor, but supporters are more likely to “go with the flow” of how households are already building while institutions leaning more towards the provider paradigm are likely to control (or attempt to control) a household’s incremental process from start to finish.

Client dissatisfaction over real or perceived problems with a house that is dictated through a forced incremental process can translate into portfolio performance challenges. Although a stated theory is that the desire to extend the house will result good repayment, provider controlled incrementalism can often result in dissatisfaction on the part of the client when the house is considered too small or the client perceives that it is taking too long to move on to the next stage of the design. When the provider controls a significant portion of the housing process, it runs counter to Turner’s Third law of housing which states that “deficiencies and imperfections in your housing are infinitely more tolerable if they are your responsibility than if they are somebody else’s”[1] (posting see Turner’s 3 Laws and Housing Microfinance, 25th July).

Stage one of a building in stages design that was deemed affordable, but was highly unpopular. It was discontinued by popular demand.

If the house in a provider controlled incremental building scheme is perceived as too small, it can also result in low demand. Strangely, (or not so strangely depending on your viewpoint), some households would rather spend their money on a larger house built to their design, even if it is made with inferior materials or is incomplete in comparison to a smaller but complete unit. Between the cost of delivery and control of provider controlled incremental building models and the potential for low demand from the target group, there are challenges to sustainable housing microfinance using this method.

Another type of provider controlled Incrementalism has clients start building at foundation level. After paying off a foundation loan, a subsequent loan might be taken for walls and later a roof, etc. Again, client dissatisfaction is not uncommon in such schemes, especially in the early stages if the client perceives that they are paying for a piece of a house that they are unable to occupy. The key here is perception. I have experienced clients with complaints about this method, when many households collect blocks and/or remain only at foundation level for even longer periods of time without complaint when they are in control of their own housing process. It all goes back to Turner’s 3rd Law, which I have come to accept as a reality in housing.

There may be cases in which a prescribed building in stages model is effective or perhaps even appropriate. It can be used in housing projects in which the provider is also providing land as part of the package. Tapping into existing incremental building requires that the households have already somehow acquired land on which they are building. Because land availability and land markets are often a serious impediment to low income households in urban and peri-urban areas, building in stages housing schemes that involve land as part of the process may be aimed serving clients without land access. Such an intervention is still likely to experience the challenges of provider controlled incrementalism, but this use aligns easily with projects that undertake green field development. An alternative option to the problem would be land access as a loan or savings product, which might be followed by support of dweller-controlled incremental building at a later time.

Another niche market for building in stages designs may be households that do not have the skills, desire or confidence to control their own housing process. In one program with which I have worked, there seemed to be anecdotal evidence that women headed households were more likely to show interest in building-in-stages type designs. There may be cases in which forced Incrementalism meets a housing need in sufficient scale to make it sustainable. I have yet to see this in Sub-Saharan Africa, but am willing to assume that it could be possible. If someone knows of provider controlled incremental housing processes in Africa that are currently reaching significant scale and are sustainable, please write in and let us know about it. Housing microfinance is still essentially in a pioneering stage in Sub-Saharan Africa, but at this point I personally believe that fitting housing microfinance into existing incremental building will be more effective and have more impact than using a controlled incremental process as a vehicle for housing microfinance.

HMF Hypothesis Four: Provider Controlled Incrementalism holds inherent challenges that will make it difficult to reach scale and sustainability as a housing microfinance option in Sub-Saharan Africa.

[1] Turner, J.F.C. (1976). Housing by People: Towards autonomy in building environments. NY: Marian Boyars. 6.