Microfinance


Microfinance consists of financial services targeting individuals and small businesses who lack access to conventional banking and related services.
Microfinance includes microcredit, the provision of small loans to poor clients; savings and checking accounts; microinsurance; and payment systems, among other services.
Microfinance product and services in MFI include:
  1. Savings
  2. Microcredit
  3. Microinsurance
  4. Microleasing and
  5. Fund transfer/remittance.
Microfinance services are designed to reach excluded customers, usually low income population segments, possibly socially marginalized, or geographically more isolated, and to help them become self-sufficient.
Microfinance initially had a limited definition: the provision of microloans to small scale entrepreneurs and small businesses lacking access to credit. The two main mechanisms for the delivery of financial services to such clients were:
relationship-based banking for individual entrepreneurs and small businesses; and
group-based model, where several entrepreneurs come together to apply for loans and other services as a group. Over time, microfinance has emerged as a larger movement whose object is: "a world in which as everyone, especially the lower income classes and socially marginalized people and households have access to a wide range of affordable, high quality financial products and services, including not just credit but also savings, insurance, payment services, and fund transfers."
Proponents of microfinance often claim that such access will help struggling classes out of poverty, including participants in the Microcredit Summit Campaign. For many, microfinance is a way to promote economic development, employment and growth through the support of micro-entrepreneurs and small businesses; for others it is a way for the disadvantaged/less privileged to manage their finances more effectively and take advantage of economic opportunities while managing the risks. Critics often point to some of the ills of microcredit that can create indebtedness. Many studies have tried to assess its impacts.
New research in the area of microfinance calls for better understanding of the microfinance ecosystem so that the microfinance institutions and other facilitators can formulate sustainable strategies that will help create social benefits through better service delivery to the low-income population.

History

Over the past centuries, practical visionaries, from the Franciscan friars who founded the community-oriented pawnshops of the 15th century to the founders of the European credit union movement in the 19th century and the founders of the microcredit movement in the 1970s, have tested practices and built institutions designed to bring the kinds of opportunities and risk-management tools that financial services can provide to the doorsteps of poor people.
The history of microfinancing can be traced back as far as the middle of the 1800s, when the theorist Lysander Spooner was writing about the benefits of small credits to entrepreneurs and farmers as a way of getting the people out of poverty. Independently of Spooner, Friedrich Wilhelm Raiffeisen founded the first cooperative lending banks to support farmers in rural Germany.
The modern use of the expression "microfinancing" has roots in the 1970s when Grameen Bank of Bangladesh, founded by microfinance pioneer Muhammad Yunus, was starting and shaping the modern industry of microfinancing. The approach of microfinance was institutionalized by Yunus in 1976, with the foundation of Grameen Bank in Bangladesh. Another pioneer in this sector is Pakistani social scientist Akhtar Hameed Khan.
Since people in the developing world still largely depend on subsistence farming or basic food trade for their livelihood, significant resources have gone into supporting smallholder agriculture in developing countries.

Poverty

In developing economies, and particularly in rural areas, many activities that would be classified in the developed world as financial are not monetized: that is, money is not used to carry them out. This is often the case when people need the services money can provide but do not have dispensable funds required for those services. This forces them to revert to other means of acquiring the funds.
In their book, The Poor and Their Money, Stuart Rutherford and Sukhwinder Arora cite several types of needs:
  • Lifecycle Needs: such as weddings, funerals, childbirth, education, home building, holidays, festivals, widowhood and old age
  • Personal Emergencies: such as sickness, injury, unemployment, theft, harassment or death
  • Disasters: such as wildfires, floods, cyclones and man-made events like war or bulldozing of dwellings
  • Investment Opportunities: expanding a business, buying land or equipment, improving housing, securing a job, etc.
People find creative and often collaborative ways to meet these needs, primarily through creating and exchanging different forms of non-cash value. Common substitutes for cash vary from country to country, but typically include livestock, grains, jewelry and precious metals.
As Marguerite S. Robinson describes in his book, The Micro Finance Revolution: Sustainable Finance for the Poor, the 1980s demonstrated that "micro finance could provide large-scale outreach profitably", and in the 1990s, "micro finance began to develop as an industry".
In the 2000s, the microfinance industry's objective was to satisfy the unmet demand on a much larger scale, and to play a role in reducing poverty. While much progress has been made in developing a viable, commercial microfinance sector in the last few decades, several issues remain that need to be addressed before the industry will be able to satisfy massive worldwide demand.
The obstacles or challenges in building a sound commercial microfinance industry include:
  • Inappropriate donor subsidies
  • Poor regulation and supervision of deposit-taking microfinance institutions
  • Few MFIs that meet the needs for savings, remittances or insurance
  • Limited management capacity in MFIs
  • Institutional inefficiencies
  • Need for more dissemination and adoption of rural, agricultural microfinance methodologies
  • Members' lack of collateral to secure a loan
Microfinance is the proper tool to reduce income inequality, allowing citizens from lower socio-economical classes to participate in the economy. Moreover, its involvement has shown to lead to a downward trend in income inequality.

Ways in which poor people manage their money

Rutherford argues that the basic problem that poor people face as money managers is to gather a "usefully large" amount of money. Building a new home may involve saving and protecting diverse building materials for years until enough are available to proceed with construction. Children's schooling may be funded by buying chickens and raising them for sale as needed for expenses, uniforms, bribes, etc. Because all the value is accumulated before it is needed, this money management strategy is referred to as "saving up".
Often, people do not have enough money when they face a need, so they borrow. A poor family might borrow from relatives to buy land, from a moneylender to buy rice, or from a microfinance institution to buy a sewing machine. Since these loans must be repaid by saving after the cost is incurred, Rutherford calls this 'saving down'. Rutherford's point is that microcredit is addressing only half the problem, and arguably the less important half: poor people borrow to help them save and accumulate assets. However, microfinance is not the magical solution to take people out of poverty; it is merely a tool that the poor can use to raise their prospects for an escape from poverty.
Most needs are met through a mix of saving and credit. A benchmark impact assessment of Grameen Bank and two other large microfinance institutions in Bangladesh found that for every $1 they were lending to clients to finance rural non-farm micro-enterprise, about $2.50 came from other sources, mostly their clients' savings. This parallels the experience in the West, in which family businesses are funded mostly from savings, especially during start-up.
Recent studies have also shown that informal methods of saving are unsafe. For example, a study by Wright and Mutesasira in Uganda concluded that "those with no option but to save in the informal sector are almost bound to lose some money—probably around one quarter of what they save there".
The work of Rutherford, Wright and others has caused practitioners to reconsider a key aspect of the microcredit paradigm: that poor people get out of poverty by borrowing, building microenterprises and increasing their income. The new paradigm places more attention on the efforts of poor people to reduce their many vulnerabilities by keeping more of what they earn and building up their assets.

Examples

The microfinance project of "saving up" is exemplified in the slums of the south-eastern city of Vijayawada, India. This microfinance project functions as an unofficial banking system where Jyothi, a "deposit collector", collects money from slum dwellers, mostly women, in order for them to accumulate savings. Jyothi does her rounds throughout the city, collecting Rs5 a day from people in the slums for 220 days, however not always 220 days in a row since these women do not always have the funds available to put them into savings. They ultimately end up with Rs1000 at the end of the process. However, there are some issues with this microfinance saving program. One of the issues is that while saving, clients are actually losing part of their savings. Jyothi takes interest from each client—about 20 out of every 220 payments, or Rs100 out of 1,100 or 9%. When these slum dwellers find someone they trust, they are willing to pay up to 30% to someone to safely collect and keep their savings. There is also the risk of entrusting their savings to unlicensed, informal, peripatetic collectors. However, the slum dwellers are willing to accept this risk because they are unable to save at home, and unable to use the banks in the country because of illiteracy. This microfinance project also has many benefits, such as empowering women and giving parents the ability to save money for their children's education. This specific microfinance project is an example of the benefits and limitations of the "saving up" project.
The microfinance project of "saving through" is shown in Nairobi, Kenya which includes a Rotating Savings and Credit Associations or ROSCAs initiative. This is a small scale example, however Rutherford describes a woman he met in Nairobi and studied her ROSCA. Every day 15 women would save 100 shillings so there would be a lump sum of 1,500 shillings and every day 1 of the 15 women would receive that lump sum. This would continue for 15 days and another woman within this group would receive the lump sum. At the end of the 15 days a new cycle would start. This ROSCA initiative is different from the "saving up" example above because there are no interest rates affiliated with the ROSCA, additionally everyone receives back what they put forth. This initiative requires trust and social capital networks in order to work, so often these ROSCAs include people who know each other and have reciprocity. The ROSCA allows for marginalized groups to receive a lump sum at one time in order to pay or save for specific needs they have.