Microfinance Essay

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The development of the microfinance sector is based on the assumption  that the poor possess the capacity to accomplish income-generating economic activities but are limited by lack of access to and inadequate provision of savings, credit, and insurance  facilities. The micro financial services capture the various financial needs of the poor, and currently microfinance is a major component of poverty reduction and economic regeneration  strategies around  the world. As a concept, microfinance pays close attention to the incentives that  drive efficient performance  in the context of small transactions  and  large numbers  of clients. Most of the institutions  in microfinance are based on group-based lending approaches and thus reduce the administrative  costs  of gathering  information,  contract design, and enforcement  of credit transactions, including  loan recovery. Recently, the  microfinance sector has come more into the domain  of commercial organizations  and the idea of sustainable microfinance has become an integral part of the development of financial markets in many countries.

Microfinance  activities  usually involve (1) small loans, (2) informal appraisal of borrowers and investments, (3) collateral substitutes such as group savings or compulsory savings, (4) access to repeat and larger loans, based on repayment  performance,  (5) streamlined  loan  disbursements and  monitoring,  and  (6) secure savings products.

According to the Consultative Group to Assist the Poor (CGAP), the key principles of microfinance are (1) the poor need a variety of financial services, not just loans; (2) a powerful instrument against poverty; (3) the need to build financial systems that serve the poor; (4) financial sustainability; (5) the need to build permanent local financial  institutions; (6) requires more than microcredit; (7) interest  rate ceilings can damage  poor  people’s access  to  financial  services; (8) the role of government  as an enabler of financial services; (9) donor subsidies should complement  private sector capital; (10) the lack of institutional and human  capacity; and  (11) the  importance  of financial and outreach  transparency.  These principles are generic and provide a broad  foundation  to the core idea of enhancing access to finance.

The CGAP principles suggest the need for a wide range of financial services that  are suitable, flexible, and reasonably priced. The financial diaries prepared by poor households in urban and rural areas in Bangladesh and in India reveal that the respondents patch together  a wide array of informal arrangements with semiformal and formal services. These diaries reveal that poor people want reliable, convenient, and flexible ways to store and retrieve cash and to turn their capacity to save into  spending  power, in the  short, medium, and long term on a continuing basis.

The ideas  of sustainability  in  microfinance  allow the continued  operation of the microfinancial services without  subsidies and help from the donor. Financial sustainability helps to reduce transaction costs, which leads to client-based  products  and services. The idea of the  poor  as a heterogeneous group  of vulnerable households with complex livelihoods demonstrates the need for client-based microfinancial services. In some cases nonfinancial services are essential for the effective use of financial services, and many microfinance institutions  integrate both services in their operations. According to CGAP, microfinance  combines banking with social goals, and capacity needs to be built at all levels, from financial institutions  through  the regulatory/supervisory bodies and information  systems, to government entities and donor agencies.

New  Institutions

There is an increasing  level of interest  from formal sector financial institutions in microfinance activities. For instance,  Bank Rakyat Indonesia’s (BRI) experience  shows that  with  attractive  savings and  credit products,  appropriate  staff incentives, and an effective system of internal regulation and supervision, the microfinance operation  can be highly profitable. The flexibility in saving services, an important part of Unit Desa Scheme of BRI, offers convenient banking hours, a friendly  atmosphere,  unconstrained withdrawals, and a range of incentives such as bonuses and raffles.

In India, the Self Help Group (SHG) program, a distinctive microfinance  program,  is based on the existing banking network  in delivering financial services. The formal financial sector  institutions  extend  loans to highly performing SHGs in certain multiples of the accumulated  savings of each SHG. The Reserve Bank of India (RBI) has instructed  all commercial  banks to participate  and extend  financing to SHGs, extending this to cooperative banks and regional rural banks. However, by the early 21st century, microfinance institutions  have become a vast global industry  involving large numbers  of governments,  banks, aid agencies, nongovernmental organizations (NGOs), cooperatives, and  consultancy  firms and  directly employing hundreds  of thousands of branch-level staff. The presence of more players in microfinance has raised certain concerns  about  the  quality and  sustainability  of the services for several reasons.

The higher  number  of players attracts  competition and brings high levels of professionalism to the industry.  But there  are concerns  about  more  players targeting  the same market,  which questions  the absorptive capacity limits on the part of both lenders and of borrowers. Irrespective of the successful citations of microfinance,  there  is a view that  microfinance has failed to see the slippery slope toward consumerism. This type of concern goes back to the ages of the previous debates on whether  microfinance  is a successful tool to address poverty alleviation. It is beyond doubt that microfinance raises the prospects for low-income  households,  and some poor people, to  achieve  their  goals—in business,  consumption, education,  health,  and  other  areas—and  is  not  a magic bullet that automatically lifts poor people out of poverty  through  microenterprise. The time  has come for microfinance institutions  as well to take up the challenge to develop diversified financial services while maintaining financial sustainability.

Bibliography:   

  1. Arun and D. Hulme, eds., Microfinance: A Reader (Routledge, 2008);
  2. Arun, D. Hulme, I. Matin, and S. Rutherford,  “‘Finance for the  Poor: The Way Forward?”  in  Finance and  Development:  Surveys of Theory, Evidence and  Policy, C. J.  Green,  C. H. Kirkpatrick,  and V. Murinde,  eds.  (Edward  Elgar, 2005);
  3.   Arun  and  P. Mosley, “SHGs in  India: A Magic Bullet for  Poor  Rural Women,”  Paper  presented   to  the  ESRC Seminar  Series on  Finance  and  Development,   University  of  Manchester  (October  30, 2003);
  4. Consultative  Group  to Assist the Poor   (CGAP),  “Key  Principles   of  Microfinance,”   cgap.org (cited March 2009);
  5. Alex Counts and Alex Counts, Small Loans, Big Dreams: How Nobel Prize Winner Muhammad Yunus and Microfinance Are Changing the World (John Wiley & Sons, 2008);
  6. Dichter, “Can Microcredit Make an Already Slippery Slope More Slippery? Some Lessons
  7. From the Social Meaning of Debt,” in What’s Wrong With Microfinance?, T. Dichter and M. Harper,  (Practical Action Publishing, 2007);
  8. Hulme  and T. Arun, “The Future  of Microfinance,” in Microfinance: A Reader, T. Arun and D. Hulme,  eds. (Routledge, 2008);
  9. G. Karmakar, Microfinance in India (Sage, 2008);
  10. Daniel Lazar and P. Palanichamy, Micro Finance and Poverty Eradication: Indian and Global Experiences (Pondicherry University, 2008);
  11. Ledgerwood, Microfinance Handbook: An Institutional and Financial Perspective (World Bank, 2000);
  12. Morduch, “The Microfinance Promise,” Journal of Economic Literature (v.37/4, 1999);
  13. Morduch and S. Rutherford, Microfinance: Analytical Issues for India,” Paper Submitted to the World Bank, South Asia Region (2003);
  14. Stuart Rutherford, The Pledge: ASA, Peasant Politics, and Microfinance in the Development of Bangladesh (Oxford University Press, 2009);
  15. D. Seibel, “The Microbanking Division of Bank Rakyat Indonesia: A Flagship of Rural Microfinance in Asia,” in Small Customers, Big Market, M. Harper and S. S. Arora, eds. (ITDG Publishing, 2005);
  16. Rajdeep Sengupta  and  Craig P. Auchubon,  “The Microfinance Revolution: An Overview,” Federal Reserve Bank of St. Louis Review (v.90/1, 2008).

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