Microfinance
Individual topical review paper on Microfinance
Executive summary
One of the major drivers of change is innovation. The development of innovations has allowed mankind to find solution of many socio-economic problems. One such innovation that has brought change in the world especially in the lives of poor is Microfinance. This paper will explore the developments of microfinance and the extent to which it has brought both economic and social change in lives of the poor. The paper would also recognise the present day limitations and criticisms of microfinance and the possible solutions to them. Later, the paper will discuss some future considerations and potentials of microfinance.
Introduction
Billions of people around the world are living in poverty. Out of which bout 1.7 billion are living in absolute poverty (Wikipedia-poverty). Often people in developing countries survive on subsistence livelihoods like subsistence agriculture. These people usually have no or little savings. This means that they have no or little income to consume goods and services or expand their businesses. They are stuck in poverty cycle. Poverty cycle is a vicious cycle of seemingly never ending poverty. One of the ways to get out of poverty is access to loans. However for many, access to loans is hard due to lack of collateral.
This problem (above) highlights the need of availability of financial services to these poor individuals. Microfinance serves as an answer to never ending poverty as microfinance is the provision of financial services such as loans to low income clients who often lack collateral.
This paper will refer to microcredit in many instances. Microcredit is a part of microfinance and means provision of small loans (of value $50 to $100) to the very poor. The provision of loans lets the poor to start their own small businesses and earn income to help their daily needs. Small loans may be offered along with training for basic entrepreneur skills and have to repaid with interest. Microcredit forms a crucial part of microfinance and therefore, it is important for us to study the effect of microfinance through microcredit.
The innovation of modern microfinance has helped changed the lives of many. It is argued that microcredit stimulates self employment encourages entrepreneurship in areas such as fishing, carpentry, agriculture.
Development of Microfinance
Historical perspective
Historically moneylenders have been one of the major sources of financial services such as provision of loans. Money lenders may be organised in form individual or family businesses. Credit would often be granted on recommendations and guarantees to persons well known to them. Loans would also be granted against collateral or securities such as gold and land and that too on high interest rates[1]. Gradually, informal money lenders were replaced to a large extent by commercial banks. Commercial banks are more organised and formal but still usually require collaterals before the loans can be provided. This implies that the poor have little access to financial/ banking services. Perhaps, this is the reason why the poor go to moneylenders and sadly often get exploited.
Since, the money lenders charge interest rates higher than the market rate and the poor people find it hard to repay back the loan, the problem of indebtedness begins. Borrowing money from informal sources is risky as misuse of money or use of money to afford daily goods such as food may result in situation where loans are used for short term benefits only. This starts cycle of indebtedness and poverty.
Credit unions and lending cooperatives and formal credit and saving institutions to serve the poor have been around for decades as well. Other sources of informal credit to the poor were charities, relatives etc.
Then in early 1700s, the Irish Loan Fund system began. It was started by author and nationalist Jonathan Swift and it is one of the earlier and longer-lived micro credit organizations that provided small loans to rural poor with no collateral. Swift's idea began slowly but by the 1840s had become a widespread institution of about 300 funds all over Ireland[2]. However, the credit of innovating modern microfinance, especially microcredit is given to Dr. Mohammad Yunus. Yunus began experimenting with lending to poor women in the village of Jobra, Bangladesh in 1970s and he later found the Grameen Bank in 1983.
Today, the World Bank estimates that about 160 million people in developing countries are served by microfinance[3]. Microfinance began as a means to alleviate poverty and not as a business. Helping poor people to create sustainable livelihoods is still the main aim of microfinance institutions. However, is microfinance sustainable? Can it reach the masses that need it most? These questions raise the conflict between serving the poor and profitability. It increases the need to make microfinance sustainable so that it can pay for itself[4]. So gradually, microfinance is now moving from charity to sustainability.
Current situation
Benefits of microfinance
Social benefits
1. Benefits to women-it helps empower women
Microfinance has allowed different communities to recognise the important role of women i.e. beyond the traditional perception that women are supposed to stay at home and tending to families. Majority of the clients of microfinance are women and 33 percent are men (who are clients of microfinance)[5]. Women are also 'human capital' and they are resources which are underutilised in many rural economies as they are often not allowed to get educated and work. Through microcredit women are allowed to work independently and live a more respectful life. It should be realised that women's poverty typically results in physical and social underdevelopment of their children[6]. Hence, when microcredit is given to a woman or group of women, they are able to start their own businesses and generate income and wealth for families. 2. Benefits to community
Microfinance and its services can greatly benefit communities and societies as the income that a family or an individual generates can in future be invested in education of children or healthcare.
Also, if more people in the community are happy or rather satisfied with their lives then there is likelihood that the crime rate or depression and suicide rates within the community may decrease.
Furthermore, self-employment along with some training regarding finance and marketing skills has made individuals more independent. Especially in areas such as agriculture and handicrafts where the middlemen would take advantage of the poor were not able to sell their products in markets directly.
Economic benefits
1. Short term benefits
Often, the poor are stuck in poverty cycle because they have little or no source of income. When the incomes are low then it is inevitable to have little or no savings. Microfinance stimulates self employment and therefore, allows the poor to earn income and save and gradually get out of the poverty cycle. It help reduces the material poverty i.e. the physical deprivation of goods and services.
2. Long term benefits
It is argued that microfinance results in economic development. Economic development refers to improvement in people's standard of lie as a result of economic growth. Many families have been able to send their children to school for education. One success story that exemplifies the points stated above:
La Maman Motuke used to live in a broken car in Zaire with her four children. She could not afford to feed her family as she had no means to do so. However, her life changed when her skill of making chikwangue (manioc paste) was recognised and encouraged by Microcredit Summit. After six months of training in production and marketing techniques and first loan of $100 USD, Maman Motuke started her own business. Today she rents a house with 2 bedrooms, sends all her children to school and is able to feed and dress them well (Marber, 2003, p. 133).
On the whole individuals all around the world may benefit from microfinance. Microfinance and its implementation contribute to achievement of Millennium Development Goals (MDGs).According to "Microfinance and the Millennium Development Goals (MDGs): A Reader's Guide", “Microfinance is one of the practical development strategies and approaches that should be implemented and supported to attain the bold ambition of reducing world poverty by half.[7]” The figures and facts below exemplify the extent to which microfinance is beneficial: ³
- In Bangladesh, Bangladesh Rural Advancement Committee (BRAC) clients increased household expenditures by 28% and assets by 112%. The incomes of Grameen members were 43% higher than incomes in non-program villages
- In El Salvador, the weekly income of FINCA clients increased on average by 145%
- In India, half of SHARE clients graduated out of poverty.
Furthermore, microfinance help meet the goal of gender equality and empowerment of women. For instance, The Women’s Empowerment Program in Nepal found that 68 percent of its members were making decisions on buying and selling property, sending their daughters to school, negotiating their children's marriage, and planning their family. Traditionally male members of families have been in charge of these activities[8]. Similarly, it is argued that when loans are taken and income is generated through microfinance, extra incomes are used further in education and health care. This means that microfinance may help contribute to MDGs concerning universal education and combating of HIV/AIDS, malaria and other diseases.
Like Mama Motuke, more families are sending their children to schools and living healthier life.
Limitations
Microfinance has certain limitations. Microfinance services such as microcredit are most effective for clients who have the ability to use the loan effectively and ability to use their generated income to pay back loans with interest. They should be able to generate income faster than rate at which they are paying interest rate[9]. If the clients fail to repay back their loans, then indebtedness is an inevitable issue. Populations that are geographically dispersed or nomadic may not be suitable microfinance candidates. Microfinance may not be appropriate for populations with a high incidence of debilitating illnesses (e.g., HIV/AIDS). Dependence on a single economic activity or single agricultural crop, or reliance on barter rather than cash transactions may pose problems. ³
The presence of hyperinflation or absence of law and order may stress the ability of microfinance to operate. Microcredit is also much more difficult when laws and regulations create significant barriers to the sustainability of microfinance providers (for example, by mandating interest-rate caps). ³
The lack of regulation is an issue that needs to be paid attention to. Poor countries where microfinance is most needed also tend to be countries with weak financial institutions and little ability to supervise them. If there is no authority like government to set rules and regulations and supervise, then the poor become more vulnerable. Without proper regulations there saving can be in risk. Hence, lack of regulation is one of the major limitations faced by microfinance.
Microfinance also often faces lack of funding. Major source of capital for many microfinance institutions (MFIs) are foreign donors, national governments and charities. MFIs may have high operating costs especially when they are small in size. If there is lack of funding it is hard for them to remain in the market. Therefore, it is important to recognise the means by which global investors can be attracted to create social businesses where the poor can be helped.
Criticisms and other issues
One may realise that most of the criticisms of microfinance are criticisms of microcredit.
Firstly, many microcredit sources charge high interest rates. According to Microbanking Bulletin reports in 2006, microfinance institutions charged interest rates as high as 22.3 per cent. On one hand, high interest rates make it harder for the poor to repay loans. Repayment becomes even harder when situations such as inflation (general and sustained increase in prices of goods and services) in economy increase. Such high interest rates make poor people's situation worse and pioneer Muhammad Yunus even believes that institutions that charge interest rates higher than 15 per cent should be penalised.
On the other hand, having high interest rates is considered reasonable as microfinance institutions also need capital to continue to operate. The source of funding is donors and if money is not repaid with interests then microfinance can not be sustainable. The issue of interest rates again highlight the need of proper regulations. Moreover, having high interest rates is reasonable when the alternatives such as informal moneylenders charge rates even higher.
Secondly, it is claimed that microcredit serves as another source of funding and the credit through microfinance institutions is misused. For instance, husbands take advantage of new funds and use it on their own consumption rather than investing these[10]. Clients may also take advantage of quick and easy credit from more than one institution. In many cases they borrowed more than they needed and even began 'bicycling' loans- i.e. paying of one loan using credit from another institution[11]. Problems of bicycling loans and misuse of loan money highlights that there is lack of education and awareness. 'According to Juan Domingo Fabbri of BankoSol's marketing department, 'multiple loans have even become a status symbol' (Rhyne, 2004, p. 145). Also there is a perception that more loans is more security and less risk. This viewpoint among the poor is dangerous and hence there is a need of awareness programs.
Future considerations
Muhammad Yunus, the founder of Grameen Bank holds a vision of total eradication of poverty from the world. He believes credit is the last hope to come out of absolute poverty and believes that the right to credit should be recognised as a fundamental human right.
Currently, microfinance faces many limitations and criticisms. So would each individual will be able to enjoy the right to credit in the future?
To enable each individual to enjoy the benefits of microfinance, firstly there is a need to overcome the limitations of microfinance. To eliminate poverty from the world, there is a need of joint efforts and contribution. The contribution by the rich and powerful should not be limited to charity only. Charity can only be helpful for a short term. There is need for strong support for social entrepreneurs. Globally social entrepreneurs should be encouraged to make process of globalisation friendly to the poor [12] (Yunnus,2007,p.249). According to Yunus, there is a need of social-objective-driven investors and institutions. Along with proper regulations, these institutions shall run and invest in research and develop and come with innovations that solve the problems of poor. Research and investment may be done in areas of flexible savings, loans for education and health and micro insurance. In short, in future financial institutions may be developed that can create and provide wide range of micro financial services.
The role of government should be recognised. Governments have to play an important role of setting a framework of rules and regulations that allow microfinance to work sustainably. Also, there is need to allow microfinance to integrate with mainstream financial systems. The framework is necessary to let the expansion of microfinance to occur at an accelerated rate. More accessibility to microfinancial services by more individuals means greater opportunities for people to come out of poverty.
With regulations the donor confidence in microfinance institutions would also rise because regulations transparency and good governance.
Similarly role of media should also be recognised. Social and mass media tools such as internet and television would help increase awareness about MFIs among the needy, potential donors and supporters of microfinance. Hence, media serves as a medium to increase the reach of microfinance to more people.
Yunus also believes in the potential benefits of information and communication technology (ICT). Yunus wants information to be available to everyone, even the poor. Microfinance can be integrated with information and communication technologies such as internet. For example, GrameenPhone brings internet- enabled phones to the Grameen borrowers who then become 'telephone ladies' of the village. By March 2003 more than 25, 000 telephone ladies were selling telephone services in Bangladesh (Yunus, 207, p.254). Many phones are even solar powered and this exemplifies how economic growth within communities can be generated sustainably.
Furthermore, the concept of microfinance can be expanded and integrated with other industries such as health and education. By integrating health education with microfinance community groups we can create a synergistic effect between the two, helping the poor to protect against and cope with health and financial shocks, seize economic opportunities, meet life-cycle needs and build assets.[13] Another example of microfinance going beyond provision of financial services is HealthStore Foundation in Kenya. 70 per cent of population of Nairobi, Kenya lives in rural areas and 80 per cent of doctors live in cities. This shows that people in rural areas have little access to healthcare because it was too far and/or expensive. HealthStore Foundation solves this problem by provision of microloans to residents of villages and training in basic health services[14]. Now the clinics offer essential drugs and health care services in remote areas and regular inspection and checking by HealthStore Foundation ensures safety.
Conclusion
Microfinance is a disruptive innovation as it has brought change in many people's life. Even though there are many limitations that the field of microfinance faces, it should be recognised that it has developed significantly. The experimental idea that began in a village of Bangladesh has expanded and reached many around the world. It is proved to be feasible and brought benefits not only in Asia and Africa, Latin America but also among the poor in America and Europe. Microfinance, the concept that began as a social activity is now becoming an industry where the poor benefits and empower. On the whole it has brought both social and economic change in the poor regions of our world.
However, one should recognise the criticism of microfinance and microcredit and then try to eliminate these criticisms and limitations through a holistic approach and joint efforts. Constructive feedback and research may be used effectively to keep improvising and developing the model of microfinance so it meets the need of changing time. A proposed manner to achieve this is by integrating microfinance not only with mainstream financial systems but also other industries. At the same time, government intervention and regulations are required.
In future, while improvising the present day microfinance, expansion opportunities of microfinance should be determined. Increasing support from media and government may help increase awareness about microfinance. Also, other technologies such as information and communication or biomedical may be exploited and integrated with microfinance so that the world of microfinance can grow beyond 'finance'.
Then hopefully, along with other measures taken to alleviate poverty, we may be able to see the world without poverty. We may be able to see each individual with right to credit.
[1] A Typology of Informal Credit Suppliers: MONEY LENDERS. (n.d.). GDRC | The Global Development Research Center. Retrieved October 5, 2011, from http://www.gdrc.org/icm/suppliers/ml.html
[2] Osborn, B. (n.d.). The History of Microfinance | Global Envision. Global Envision | The Confluence of Global Markets and Poverty Alleviation. Retrieved October 6, 2011, from http://globalenvision.org/library/4/1051/
[3] About Microfinance | Kiva. (n.d.). Kiva - Loans that change lives. Retrieved September 30, 2011, from http://www.kiva.org/about/microfinance#theHistoryOfModernMicrofinance
[4] Harper, M. (2003). Introduction. Microfinance: evolution, achievements and challenges (p. 7). Warwickshire: ITDG.
[5] Who are the clients of microfinance?. (n.d.). CGAP. Retrieved October 2, 2011, from www.cgap.org/p/site/c/template.rc/1.11.947/1.26.1304/
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[7] Kesner, L., International, S. o., Affairs, P., & University, C. (n.d.). MICROFINANCE MATTERS - Redefining Microfinance as a Strategy to Achieve the MDGs. UNCDF / FENU. Retrieved October 7, 2011, from http://www.uncdf.org/english/microfinance/pubs/newsletter/pages/2005_09/update_redefining.php
[8] Littlefield, E., Morduch, J., & Hashemi, S. (2003). Is Microfinance an effective strategy to reach Millennium Development Goals. CGAP Focus Note, No.24. Retrieved October 8, 2011, from http://www.cgap.org/gm/document-1.9.2568/FN24.pdf
[9] When is microcredit not the answer?. (n.d.). CGAP. Retrieved October 8, 2011, from www.cgap.org/p/site/c/template.rc/1.11.947/1.26.1313/
[10] Quddus, M. (n.d.). Yunus Centre :: A rebuttal of the criticism of microfinance. Yunus Centre. Retrieved October 9, 2011, from http://www.muhammadyunus.org/Yunus-Centre-Highlights/a-rebuttal-of-the-criticism-of-microfinance/
[11] Rhyne, E. (2001). Competition, commercialization and the crisis of microfinance. Mainstreaming microfinance: how lending to the poor began, grew, and came of age in Bolivia (p. 145). Hartford: Kumarian Press.
[12] Yunus, M., & Jolis, A. (2003). The Future. Banker to the poor: micro-lending and the battle against world poverty (p. 249). New York: Public Affairs. (Original work published 1997)
[13] Financing Healthier Lives - The Microcredit Summit Campaign. (n.d.). The Microcredit Summit Campaign. Retrieved October 10, 2011, from http://www.microcreditsummit.org/financing_healthier_lives/
[14] Christensen, C. M., Baumann, H., Ruggles, R., & Sadtler, T. M. (2006). Disruptive innovation for social change. Harvard Business Review, 84(12), 94-101. Retrieved October 22, 2011, from the EBSCO Host database.
