Microfinance: An Introduction

The most significant finding in the last two decades in the world of finance did not come from the world of the rich or the relatively well-off people. More importantly the poor can save, can borrow and can certainly repay loans. This is where the concept of microfinance lies. Microfinance can be defined as a type of banking service that is provided to unemployed or lowincome individuals or groups who would otherwise have no other means of gaining any sort of financial services. The ultimate goal of the banking service is to give low income people an opportunity to become self-reliant through the provision of saving money, borrowing money and insurance. A good definition of microfinance as provided by Robinson is, Microfinance refers to small-scale financial services for both credits and deposits that are provided to people who farm or fish or herd; operate small or microenterprises where goods are produced, recycled, repaired, or traded; provide services; work for wages or commissions; gain income from renting out small amounts of land, vehicles, draft animals, or machinery and tools; and to other individuals and local groups in developing countries, in both rural and urban areas. The term microfinance is often used more narrowly to refer to the provision of loans and other services from providers that identify themselves as microfinance institutions (MFIs). These institutions commonly tend to use new methods developed over the last 3 decades to deliver very small loans to the poor. These methods include group lending and liability, pre-loan savings requirements, gradually increasing loan sizes, and an implicit guarantee of ready access to future loans if present loans are repaid fully and at the appointed time. More broadly, microfinance refers to a movement that envisions a world where low-income households have permanent access to a range of high quality financial services to finance their income-producing activities, build assets, stabilize consumption, and protect against risks. These services are not limited to the provision of credit, but include savings, insurance, and money transfers. Microfinance encompasses with some broad category of services, which includes microcredit. Microcredit is the provision of credit services to the low income groups.

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Microfinance Program: Pitfalls and Potentials

Pitfalls of Microfinance Program

Microfinance has long been considered as the solution to the problems of the poor. It attempts to lift the poor out of poverty by giving them credit to expand their horizon of opportunity. Despite having a good intention the program has to face some hurdles more or less. Some of them are piled up below: Macro-level Pitfalls: Policy environment There has been a general improvement in the policy environment for financial sector programs in many countries of the world. Nevertheless, the policy environment for microfinance in many countries remains unfavorable for sustainable growth in microfinance operations. For example, in countries such as Peoples Republic of China, Thailand, and Viet Nam, and the ceilings on interest rates limit the ability of MFIs to provide permanent access to an increasing segment of the excluded households. Furthermore, DMC (Development Member Country) governments inappropriately and extensively intervene in microfinance to address the market failure through channeling microcredit to target groups that are considered to have been underserved or not served by existing financial institutions. With subsidized interest rates and poor loan collection rates, these interventions weaken sustainable development of microfinance. As a result, most DMCs are crowded with poorly performing government microfinance programs that distort the market and discourage private sector institutions from entering the industry. Inadequate financial infrastructure Inadequate financial infrastructure is another major constraint for microfinance program. Financial infrastructure includes legal, information, and regulatory and supervisory systems for financial institutions and markets. Most governments have focused on creating institutions or special programs to disburse funds to the poor with little attention to building financial infrastructure that supports, strengthens, and ensures the sustainability of such institutions or programs and promotes participation of private sector institutions in microfinance. The other major financial infrastructure-related problems include lack of (i) a legal framework conducive for emergence and sustainable growth of small-scale financial institutions, (ii) regulatory and supervisory systems for microfinance in countries where the microfinance subsector is

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approaching a level of maturity, and (iii) emphasis on development of accounting and auditing practices and professions. Limited retail level institutional capacity Most retail level institutions do not have adequate capacity to expand the scope and outreach of services on a sustainable basis to most of the potential clients. Many institutions (i) lack capacity to leverage funds, including public deposits, in commercial markets; (ii) are unable to provide a range of products and services compatible with the potential clients characteristics; (iii) do not have an adequate network and delivery mechanisms to cost-effectively reach the poorest of the poor, particularly those concentrated in resource-poor areas and areas with low population densities; (iv) do not show a vision and a commitment to ensure their financial soundness and sustainability within a reasonable period, and become subsidy independent; and (v) do not have the capacity to manage growth carefully. Most of the state-sector institutions or programs that provide microfinance services have been created within and nurtured by a distorted policy environment characterized by various degrees of financial repression. They do not have a business culture. Even new institutions created by the governments in most DMCs are unable to provide good quality services, let alone expand their services on a sustainable basis. Inadequate investments in rural development The insufficient investments in physical infrastructure especially irrigation; roads; electricity; and support services for marketing, business development, and extension continue to increase the risk and cost of microfinance and particularly discourage private investments in the provision of microfinance services on a significant scale. Also, in the absence of economic opportunities created by growth-inducing processes, microfinance cannot be expected to play a significant role in poverty reduction. Inadequate investments in social intermediation The low level of social development is a major constraint on the expansion of microfinance services on a sustainable basis. This is particularly true with respect to the poorest, women in poor households, poor in resource-poor and remote areas, and ethnic minorities. A vast amount of financial and human resources is required to address this issue. Private sector MFIs are not likely to invest in social intermediation given the externalities associated with such investments.

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Microfinance Program: Pitfalls and Potentials

The development of sustainable microfinance to reach a large segment of the potential market requires supporting social intermediation on a large scale.

Macro-level Pitfalls:

Delay in service delivery: Delay in service delivery is a common phenomenon of this program. Experience shows that due to delay or long time in processing any loan or other services, poor households are compelled to go to the loan sharks. The major obstacle for the poor households appear to be the unavailability of instant and fast supply of credit or loan in the event of emergency need. Multiple borrowing is a serious concern: Multiple borrowing has become a major problem of this program. Recent experience shows that many female borrowers move away forever from their home due to inability to repay their multiple loans. More dangerously, there were many examples of suicide by the indebted borrowers in the different regions. Moreover, to repay the multiple borrowing, many poor households are compelled to go to the lone sharks and become landless.

Severe lack of training and education: A great degree of inefficiency exists at the borrowers as well as the management level of the microfinance institutions. The employees and the higher management of MFIs are not adequately skilled in delivering efficient financial services. This also prevents innovation from developing in this sector at the grass root level.

High turnover rate and unfair competition: The turnover rate of skilled manpower is very high in the microfinance sector. This is quite evident that large MFIs always attract highly skilled staffs of the relatively small MFIs. Because of the large deviation in terms of capabilities and size, relatively small MFIs always feel pressure in the market, and thus face unfair competition from the large MFIs not only in terms of skilled employee turnover but also increasing market share. This is a great concern that a chronic unhealthy competition exists among the NGOs in loan disbursement and increasing outreach. Misuse of credit causing more miserable lives for borrowers: A major and probably the most responsible cause for the ineradicable misery of the poor people is the misuse of credit by borrowers. Borrowers either fail to utilize the credit properly due to inexperience or lack of capacity or they may intentionally use the loan amount for purposes other

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than the one promised while taking the loan. Such borrowers are often found defaulting on repayment of the loan. Lack of central database: There must be a central database for the microfinance industry in Bangladesh. The Credit and Development Forum (CDF) has been putting in their efforts for last couple of years but unfortunately they could not succeed up to the desired level as many NGOs are left out, and in many cases required information cannot be collected due to diverse nature of problems encountered.

Sectoral disbursement without technical experts:

The days of disbursing loan to any sector are over. In this huge industry, NGO MFIs disburse loan to many investment sectors but in major cases they do not have proper technical persons experienced in those investment sectors. Lack of intention to serve in the apparently inaccessibly location: Despite the rapid growth of the microfinance sector and disbursement of a large volume of money, yet there are many parts of the country out of the network of microfinance institutions. Experience shows that NGO MFIs do not intend to operate in many distant places (i.e. Char areas) that are termed as inaccessible and not cost-effective. They feel it as a burden, a complicated job and also hard-to-profit activity. Other pitfalls:

Difficulty in measuring the social performance of MFIs Read about tools to help measure the social impact of microfinance.

Mixing of charity with business by microfinance providers; this is an issue of poor governance. High interest rates of loans made to the poor to cover various costs and risks. Lack of customized solutions/ microfinance models for the poor. Inappropriate targeting of poor households by microfinance programs. Poor distribution system of MFIs, i.e. a need to spread out loan facilities into rural areas. Lack of information about microfinance investment opportunities. Poor institutional viability of microfinance ventures. Dual mission of MFIs to be financially sustainable as well as development oriented.

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Potentials of Microfinance Program

According to CGAP, "Comprehensive impact studies have demonstrated that:

Microfinance helps very poor households meet basic needs and protect against risks The use of financial services by low-income households is associated with improvements in household economic welfare and enterprise stability or growth;

By supporting women's economic participation, microfinance helps to empower women, thus promoting gender-equity and improving household well-being;

For almost all significant impacts, the magnitude of impact is positively related to the length of time that clients have been in the program."

Poor people, with access to savings, credit, insurance, and other financial services, are more resilient and better able to cope with the everyday crises they face. Even the most rigorous econometric studies have proven that microfinance can smooth consumption levels and significantly reduce the need to sell assets to meet basic needs. With access to micro insurance, poor people can cope with sudden increased expenses associated with death, serious illness, and loss of assets. Access to credit allows poor people to take advantage of economic opportunities. While increased earnings are by no means automatic, clients have overwhelmingly demonstrated that reliable sources of credit provide a fundamental basis for planning and expanding business activities. Many studies show that clients who join and stay in programs have better economic conditions than non-clients, suggesting that programs contribute to these improvements. A few studies have also shown that over a long period of time many clients do actually graduate out of poverty. By reducing vulnerability and increasing earnings and savings, financial services allow poor households to make the transformation from "every-day survival" to "planning for the future." Households are able to send more children to school for longer periods and to make greater investments in their children's education. Increased earnings from financial services lead to better nutrition and better living conditions, which translates into a lower incidence of illness. Increased earnings also mean that clients may seek out and pay for health care services when needed, rather than go without or wait until their health seriously deteriorates."
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Empirical evidence shows that, among the poor, those participating in microfinance programs that had access to financial services were able to improve their well-being-both at the individual and household level-much more than those who did not have access to financial services. Microfinance Can Be a Good Tool for Empowering Women Microfinance programs have generally targeted poor women. By providing access to financial services only through women-making women responsible for loans, ensuring repayment through women, maintaining savings accounts for women, providing insurance coverage through women-microfinance programs send a strong message to households as well as to communities. Many qualitative and quantitative studies have documented how access to financial services has improved the status of women within the family and the community. Women have become more assertive and confident. In regions where women's mobility is strictly regulated, women have become more visible and are better able to negotiate the public sphere. Women own assets, including land and housing, and play a stronger role in decision making. Major achievements in microfinance The MFIs and other financial institutions (OFIs) providing microfinance services have expanded their outreach from a few thousand clients in the 1970s to over 10 million in the late 1990s. The developments in microfinance in the Region have set in motion a process of change from an activity that was entirely subsidy dependent to one that can be a viable business. (i) MFIs and OFIs mobilizing voluntary savings have shattered the myth that poor households cannot and do not save, and proved that savings can be successfully mobilized from poor households. This is perhaps a more important achievement of microfinance in the Region than the expanded outreach in access to credit. (ii) MFIs, OFIs, and their clients have shown that the poor are creditworthy (poor women, in particular) and financial services can be provided to and accessed by the poor on a profitable basis at low transaction costs without relying on physical collateral, if it is done with appropriate financial technology and a commitment to achieve efficiency. (iii) Microfinance services have triggered a process toward broadening and deepening of rural financial markets.
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(iv) Microfinance services have strengthened the social and human capital of the poor, particularly women, at the household, enterprise, and community level. (v) Sustainable delivery of microfinance services on a large scale in some countries has generated positive developments in microfinance policies and practices among all stakeholders: governments, central banks, microfinance service providers, and external funding agencies. Successes of microfinance in developing countries Research points to a range of successes for microfinance programs in developing countries: 1. Microfinance increases access to financial services where such access may not otherwise exist. According to the State of the Micro-credit Summit Campaign 2001 Report, 74% of the worlds poorest women (19.3 million) now have financial access through microfinance. 2. Microfinance offers economic growth for some participants. Evidence from various MFIs in Bangladesh indicates that microfinance reduces the economic vulnerability of members, particularly for women. In a study of four MFIs in Bolivia, all had positive impacts on income and asset levels, although clients average debt-service ratios were quite high. In Zambia, borrowers who obtained a second microcredit loan experienced higher average growth in business profits as well as household income. 3. Microfinance may build communities and social capital. While there is little empirical

research on the impact of microfinance programs on social capital and community building, numerous researchers posit a positive relationship between the two. Preliminary evidence suggests that womens involvement in microfinance groups has stimulated collective action against broader public issues. 4. Microfinance may increase womens agency in intra-household decision-making. Some

microcredit programs have been shown to increase womens ability to exercise agency in intrahousehold processes, including inter-spouse consultation, autonomy, and authority. Survey data from South India illustrates that when microcredit involves group membership, women tend to be more likely to exhibit joint and female decision-making in the household, a pattern that strengthened with longer-term group membership, the frequency of group meetings and intensity

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of training. Still, other studies have shown only modest improvements in decision-making status, arguing that social norms are difficult to change in the short term. 5. Microfinance may foster the broader empowerment of women. In a study of the two largest and most well-known MFIs in Bangladesh, the Grameen Bank and the Bangladesh Rural Advance Committee (BRAC), the duration of membership in either MFI was positively associated with empowerment as defined by meeting five of the following seven indicators: ability to make small purchases, large purchases, or both; decision-making power in the household; mobility; ownership of assets; self-control and self-determination within the household; knowledge of legal rights; involvement in political protests. 6. Microfinance may improve child health and welfare. In Bangladesh, microfinance has been shown to lead to improvements in the nutritional status of children as compared to nonparticipants. 7. Microfinance may increase contraception use among participants.In Bangladesh, microfinance participants have been found to be more likely to use contraception than non-participant controls. However, findings from another study in Bangladesh showed no increase in contraceptive use among female participants, and a slight increase for male participants Bundled microfinance and health initiatives may have compounding benefits. Microfinance programs that incorporate health education or other health initiatives may positively impact health as well as economic outcomes. In a study comparing three communities in the Dominican Republic receiving a health promotion program, a microfinance program, and both programs simultaneously, results indicated that the community receiving both programs had the largest changes in 10 of 11 health indicators.

Concluding Remarks
Let us be clear: microfinance is not charity. It is a way to extend the same rights and services to low-income households that are available to everyone else. It is recognition that poor people are the solution, not the problem. It is a way to build their ideas, energy and vision. It is a way to grew productive enterprises, and to allow communities to prosper.- Kofi Annan. So, constraints of the program and corresponding solutions should be sorted out properly and hence, a better world should be ensured for the poorer section of our community.
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References:
(i). Does Micro-finance really Benefit the Poor? (2001), viewed on 5 May 2011 URL: www.adb.org/poverty/forum/pdf/Khandker.pdf (ii) Microfinance (2010), viewed on 5May 2011 URL: http://www.answers.com/topic/microfinance (iii). Microfinance Definition, Sources and Problems (2010), viewed on 2 May 2011 URL:http://microfinancehub.com/2010/01/31/what-is-microfinance-defition-sourcesproblems/ (iv). The Benefits of Microfinance: Revisited (2010), viewed on 2 May 2011 URL: http://www.cgap.org/p/site/c/template.rc/1.26.14616/ (v). Microfinance and why it may not work (2006), viewed on 4May 2011 URL: www.planetd.org/.../microfinance-and-why-it-may-not-work/ 2006

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