Microfinance

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Microfinance is a term for the practice of providing financial services, such as microcredit, microsavings or microinsurance to poor people.^[1] By helping them to accumulate usably large sums of money, this expands their choices and reduces the risks they face.^[2] As suggested by the name, most transactions involve small amounts of money, frequently less than US$100.^[3]

Contents 1 History 2 Types 3 Microfinance and development 4 Development of the sector in India 5 Criticism 6 Key debates 7 See also 8 Notes

[edit] History

The origin of microfinance is often dated as late as the 1970s. Only then, it is often argued, did any programs pass two key tests:

• to show that poor people can be relied on to repay their loans, and
• to show that it's possible to provide financial services to poor people through market-based enterprises without subsidy.

Recent evidence gathered by Timothy Guinnane, an economic historian at Yale, raises questions about this view. Guinnane demonstrates that the success of Friedrich Wilhelm Raiffeisen's village banking movement in Germany, which actually began in 1864 and reached 2 million rural farmers by 1901, resulted in large part from its ability to pass both these tests.

Guinnane shows how the village-based bonds of association of these early credit unions gave them both the information and enforcement advantages needed to make loans to people who were both too poor and too remote to access bank loans.^[4] Raiffeisen was moved to action by the poverty of the recently freed serfs, and by the degree of exploitation they faced from local moneylenders.^[5]

The caisse populaire movement founded by Alphonse Desjardins in Quebec, also met these tests. Desjardins and his wife Dorimène had strong faith in these principles, founding the first caisse in 1900 (which she managed), until 1906, when a law governing them was passed in the Quebec assembly.^[6].

Like Raiffeisen, Desjardins was concerned about poverty. But he was spurred to action by his outrage over usury. In 1897 as parliamentary reporter, he learned of "one notable [court] case in Montreal within the last few days, in which a man obtained a loan of $150, and was sued for, and was compelled to pay in interest, the sum of $5,000".^[7]

In the 1970s, a new wave of microfinance initiatives introduced many new innovations into the sector. Solidarity lending emerged as a distinctive new methodology, made famous by Dr. Muhammad Yunus, the founder of Grameen Bank, who was awarded, together with Grameen Bank, the Nobel Peace Prize in 2006.

[edit] Types

Kasmonie: In Suriname, an informal financial savings and loan system exists. It is called “kasmonie” or “cash-money”. In this system a self-selected group of trusted individuals agrees “to save a fixed amount of money on a periodical basis and each of them in turn receives the whole pool once. It is generally used by microentrepreneurs.

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[edit] Microfinance and development

Today, microfinance plays a major role in the development of many African, Asian, and Latin American nations. Its impact is substantial enough to have warranted acknowledgment by the United Nations who declared 2005 "The international year of microfinance", reminding people that millions worldwide benefit from microfinance activities.^[8]

[edit] Development of the sector in India

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In India, microfinance traces its roots to mid 1970s when some prominent Indian NGO like Myrada & Pradan started using the Self Help Group (SHG) model. The SHG is used as a platform for social mobilization and finance is one of the various services provided to the grassroot community through this model. It was widely replicated across other developmental NGOs.

It is a community driven and managed microfinance model where the NGO plays the role of a facilitator, for instance providing capacity building services to the groups and building relationships with banks.

During the late 90's , the Grameen model promoted by Muhammad Younus of Grameen Bank and the ASA model promoted by the Association for Social Advancement, both from Bangladesh, found rapid acceptance amongst the newer breed of microfinance institutions in India. This was due to the models' capability for rapid scaling in terms of client outreach. Also these models are less dependent on donor funds and passes the actual service charge to the clients while retaining a margin for its own growth. These models have proven to be robust revenue models.

Slowly a distinct trend of shifting from non profit, grant-supported organizations to for profit institutions (non-banking financial corporations) became visible in Indian microfinance sector.

[edit] Criticism

There is, however, criticism towards microfinance institutions. In 2001, a Wall Street Journal article raised questions about the Grameen Bank,^[9] including repayment rate, collection methods and questionable accounting practices.

Microlending in developed countries was exposed in a 2007 BusinessWeek magazine article in abusive practices due to lax bankruptcy, consumer protection and interest rates laws in these countries.^[10]

On a larger scale, some argue that if microfinance is a successful anti-poverty program, then government welfare could be shrunk or eliminated as inefficient.^[11]

Research on the actual effectiveness of microfinance as a tool for economic development remains slim, in part owing to the difficulty in monitoring and measuring this impact.^[12] Questions have arisen regarding whether microfinance can ever be as important a tool for poverty alleviation as its proponents and practitioners would submit.^[13]

It is not widely known that interest rates charged to borrowers frequently range from 2.5% to a 4% a month (about 31% to 50% a year), depending on the country.^{[citation needed]} This is justified to pay staff salaries and technical assistance from rich countries.^{[citation needed]} Microfinance institutions argue that rates are not really high compared with those charged by local money lenders (often over 10% a month). They also point out that if their interest rates were not fair, they would have fewer borrowers and more delinquencies than in fact, they do. But it is quite controversial that they charge such high interests to poor individuals, with money that is often donated.^{[citation needed]} Furthermore, the experience of microfinance organizations shows that interest rate has usually secondary significance for microborrowers. The factors of more significance are access to credit, processing time, level of bureaucratic requirements, collateral requirements, etc. Thus the clients can prefer an institution even if the interest rate is very high but the level of bureaucratic requirements is low to an institution charging much lower interest rate but with higher bureaucratic requirements (for instance traditional banks). The level of interest rate charged by microfinance institutions can be justified by high margins achieved by microentrepreneurs. For instance, a cloth trader in Central Asia can easily have margins of 100% with high rotation of working capital. That means that additional cash circulating in the business generates additional profit that easily allows for loan repayment.

There are examples of intransparent price policy with interest rate charged to the borrowers not disclosed by the micro finance institutions (which receive donations). However, in the countries with underdeveloped financial market also commercial banks can have intrasparent lending conditions misleading potential clients.

There are, however, institutions offering microcredit with no expectation of profit. See MicroCredit Enterprises, founded by Jonathan Lewis.

[edit] Key debates

One key debate within microfinance has been whether donors and practitioners should focus on impact, i.e. improved living standards for the poor, or financial sustainability. The former approach has been called 'poverty lending' or 'the welfarist approach', whereas the latter is sometimes termed 'the institution-building' or 'financial system approach'.^[14] Whereas the welfarist approach often supplements financial services with other services such as education and health, institution-builders focus solely on financial service.

The arguments for this approach are that:

1. if poor people are willing to pay to use the institution, it must be offering them value
2. only by ensuring financial sustainability can the huge demand be met
3. donors are best to direct subsidies to other services like education and health through separate non-profit organizations.

Examples of the welfarist approach are Pro Mujer, FINCA International, and Freedom From Hunger. Examples of the institution-building approach are ACCION International, BRI Unit Desa, and Women's World Banking.

Another key debate centers on the appropriate target group for microfinance services. One view is that the most important form of microfinance is credit targeted to poor people who are also talented entrepreneurs. If these people gain access to credit, they will expand their businesses, stimulate local economic growth and hire their less entrepreneurial neighbours, resulting in fast economic development. While this approach has had significant results in the cities of the developing world, it has failed to reach the majority of poor people, who are rural subsistence farmers with little, if any, non-farm income. As urban-rural income inequities continue to rise in the developing world, this result is increasingly viewed with dissatisfaction.

The World Bank estimates that of approximately 1.2 billion people who subsisted on less than US$1 a day in 2003, 850 million lived in rural areas.^[15] There is increasing recognition that poor people can and do save informally at home -- but lose much of their savings because home is a risky place to save.^[16] There is also recognition that before rural farmers will have the confidence to start businesses, they must be able to gain more control over other household risks such as hunger, disease and natural disaster. This requires access to safe, flexible small-balance savings accounts.

A new microfinance paradigm is taking shape, with the goal of developing full-service for-profit banks for all poor people. This approach is exemplified by the transformations at Grameen Bank (referred to as 'Grameen II') since 2000 and has been championed by practitioners such as Stuart Rutherford, Graham Wright, Madeleine Hirschland and Marguerite Robinson. The Consultative Group to Assist the Poor (CGAP) has also published extensively on the new microfinance. These banks will be able to support their clients' efforts to control family risks as well as capitalize on business opportunities. They will offer savings, insurance, remittance services, and personal and business loans, to help clients grow their assets while increasing their incomes.

[edit] See also

• Sustainable development

[edit] Notes

cs:Mikrofinancování

da:Mikrofinans de:Mikrofinanz es:Microfinanza it:Microfinanza nl:Microkrediet no:Mikrofinans ru:Микрофинансирование tr:Mikrofinans