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|Tuesday, 07 August 2012 07:33|
This week's invited contributor is Cornell University's Lila Nojima who has shared with us an interesting piece on microfinance.
As Lila says, microfinance is one of the major buzz words in both the banking and development spheres. But what exactly is microfinance?
Microfinance can be defined as the provision of a range of financial services to poor households and their enterprises. Financial services include savings accounts, insurance, credit and loans, and money transfers, in addition providing financial advice to those who generally lack access to such information. Most simply, microfinance is a method of poverty alleviation.
Poor, especially rural, communities lack a safe place for individuals to store their money. In this way, microfinance organizations can provide these people with a secure method of storing their money. Additionally, through deposit accounts, individuals can accrue interest and build up credit. As with the majority of microfinance services, organizations must be proactive with their savings accounts, for example, going from home to home, or village to village collecting and depositing people’s money. These organizations can also provide insurance, in the form of business insurance, health or life insurance, etc. These individuals would normally be excluded from such insurance policies, and through microfinance, they are given a certain amount of cushion in the case of misfortune. Money transfers may not seem like an obvious function of a microfinance bank, but they are extremely important. For example, the transfer of very small amounts of money tends to be very costly, making it very inefficient. By providing transfer services, poor individuals and families can send small amounts of money to their families members in need. This also allows for family members to send small remittances back to their rural, or hard to reach, relatives.
The provision of credit and loans to poor households and unsalaried workers is probably the most famous function of microfinance. Microcredit lends primarily to those who traditional banks would not deem credit-worthy, including women and the very poor. These borrowers may lack collateral or a steady salary, so to mitigate the dangers of lending to these individuals, microcredit lenders tend to rely on borrower groups. For example, a bank will assemble a group of 7 local women, but only lend to two, with the condition that the others will only receive loans if the first two repay. This method of peer pressure in the place of collateral is highly effective and defaults are uncommon. Credit lines to the poor are invaluable, as they allow these individuals to have greater control over their lives; they can purchase items they may not be able to otherwise and it allows them to avoid predatory, unethical moneylenders.
Asia is the main recipient of microfinance, and given its vast population, also has the largest number of poor households in the world. Asia is also a prime location for microfinance. Poor households generally lack access to financial services, and there is a rapidly growing middle class. This middle class is not the same as the middle class of the United States and western nations. Being middle class in Asia can mean simply living above a couple of dollars a day; middle class families are still in very precarious situations and small things can throw them back into poverty. Microfinance and credit can ease the disparities in their daily incomes and help them continue to save and stabilize their lives. Finally, Asia is known for its lack of women’s power and rights. From the One Child Policy in China to sex selective abortions in India, women are often seen as second class citizens. By giving women access to financial services and loans to start their own businesses, microfinance empowers women and allows them to support themselves.
The Grameen Bank in Bangladesh, founded by Muhammad Yunis in 1976 is the first microfinance bank. Yunis lent using the borrower group model with the aim of giving the poor access to credit while also teaching them necessary financial skills. Understanding banks and loans is very important for these individuals as it helps them avoid falling prey to unscrupulous moneylenders. The Bank provides low interest rates on loans and attractive rates for deposits, and because of this, repayment and savings rates are very high. 97% of Grameen Bank’s members are women and 65% of its members have crossed the poverty line, according to the Bank’s website. Grameen Bank functions are the model for microfinance banks around the world, and many other private microfinance banks have emerged in the region.
China seems like a prime market for Grameen-style microfinance services, with about 394.6 million people living under $2 a day. However, the Chinese poor face very different challenges than Bangladeshis. Firstly, China is much larger than Bangladesh, both in population and land mass, and the population is much less concentrated. This means it is harder for small banks to gain a foothold and reach large amounts of people. For example, while most Bangladeshis are concentrated in the cities, many Chinese families are spread out across hard to reach, rural terrain. Additionally, it is much easier for the poor in China to access financial services than it is for the poor in many other countries. This reduces the demand for microfinance banks. Due to these challenges, the Chinese government has emerged as the largest microfinance provider in China. Beginning in 1994, the Chinese government experimented with different styles and methods of microfinance, and by 2005, it had gained traction as a legitimate government policy to alleviate poverty. In the future, it will be interesting to see the trajectories of these two models of microfinance: private in Bangladesh vs public in China.
While Grameen Bank and the Chinese government seem to be benefiting the poor with their financial services, microfinance is also marred by negative impacts and unethical practices. The most famous example of these occurred in 2010 in Andhra Pradesh, India, when large numbers of suicides were committed by micro-borrowers. Andhra Pradesh had been one of the largest microfinance markets, and due to irresponsible actions by the banks, suffered from a microbanking crisis. Lenders were not socially responsible, offering loans that they knew were too large to be repaid, charging high interest rates of loans, and overburdening borrowers with multiple loans. Additionally, there was a lack of government oversight of the microfinance industry. This crisis in Andhra Pradesh shed light on an industry many thought was always beneficial, and reminded everyone that sometimes the power of profit can outweigh good intentions.
Microfinance is not limited to developing nations, and Muhammad Yunis has stated that even developed countries can benefit from it. One example of this is using microfinance to benefit those impacted by the 2011 earthquake in Japan. The earthquake, which led to the closing of the Fukushima nuclear plant, not only forced many to temporarily evacuate, it also caused many individuals to lose their jobs and assets. Yunis has asserted that microcredit could help those who lost their jobs and home rebuild. Further, microcredit could help these unemployed individuals start small businesses, which would benefit the struggling Japanese economy as a whole. Microfinance has also been used in the United States where poor communities and individuals lack access to financial services and understanding of financial processes.
Many criticisms have been levied against microfinance, many of which are valid points of concern. For example, many argue that microfinance diverts resources from ore important poverty alleviation projects, such as education and infrastructure. Others assert that there is a low demand for the goods produced by microenterprises. In a poor community, there is often a lack of demand for goods, and the microenterprises often go out of businesses. There is also the issue of harm to borrowers when banks do not act in the best interests of their borrowers, as outlined above in the Andhra Pradesh example. Finally, there is a lack of good, statistical evidence either in favor of, or against, microfinance. Most data is anecdotal and it is often hard to keep track of the borrowers once they stop using the services.
Keeping all these criticisms in mind, I do believe that microfinance is still a useful and beneficial tool for the poor, and it is still the primary method of getting money directly into the hands of the poor. It educates individuals about financial services and prevents them from being taken advantage of, even when they stop using the microfinance banks, and the multiplier effect on communities can be quite powerful. For example, if one family begins to make more money via a microenterprise they started from a microloan, they will be able to spend more on food, increasing the income of the food producer, who will then be able to spend more money on clothes, increasing the income of the individual who produces clothing, and so on and so forth. In these ways, I think when done responsibly and with the best interests of the poor in mind, microfinance is a powerful way to end poverty and better the lives of those in need.