Financial Services and Environmental Health: Household Credit for Water and Sanitation

This paper is directed toward technical professional staff in USAID who are responsible for designing programs and projects, advocates the use of microfinance institutions as an integral part of financing strategies for increasing water supply and sanitation coverage in urban and peri-urban areas. Policy makers and program designers in non-governmental organizations (NGO's) and international financing institutions also may find much that is relevant to their attempts to incorporate microfinance within the design of a wide range of activities.

The paper examines the role of microfinance in water supply and sanitation and concludes that:

• Proposals to finance any activity with channeled and/or subsidized household credit should be treated with caution;
• Subsidies should only be given in a way that minimizes distorting effects on incentives to save and borrow;
• There may also be indirect effects on the viability of informal suppliers of financial services, and clumsy attempts at innovation may destroy effective indigenous financial institutions;
• Fortunately, since the demand for credit is so high the impact on existing credit sources will be minimal, provided interest rates are set with respect to costs.

The paper looks at the examples of such initiatives in several developing countries such as Lesotho, Honduras, India, Ghana, Bolivia, Kenya, Philippines, Indonesia, Bangladesh and Pakistan. The section concludes that:

• The definition of productive investment can be extended to include housing, education, health and even consumption but that would miss the point;
• A reasonable hypothesis would be that a minimalist approach to credit provision, one avoiding the excessive compliance costs of channeled and targeted credit, is more effective means of catalyzing the economic development of peri-urban society.

The paper makes the following general recommendations:

• Credit should be used to support on-site water and sanitation investments in peri-urban areas;
• Funds available from water and sanitation, housing improvement and health budgets should also be available to support intermediaries that are even more diversified;
• Although minimalist credit programs are probably the most efficient, the absence of appropriate institutional vehicles means that, in the medium term, the support of credit unions and specialized private voluntary organization credit programs is needed;
• All credit and savings programs should be subject to some system of prudential regulation and monitoring;
• Where such regulation is available, savings schemes should be promoted as a way of preparing for future intermediation by a financial institution supplying loan products;
• More detailed and comprehensive set of case studies of the most promising approaches should be compiled over a long enough period and with adequate resources, to support firm conclusions on guidelines for developing specialist and general financial institutions in urban and peri-urban areas;
• Resources should not be expended on extensive microfinance development in countries lacking sound macroeconomic management now and in the foreseeable future.