- Q1. What is microfinance?
- Q2. What is a microfinance institution (MFI)?
- Q3. How did microfinance as an industry evolve?
- Q4. Why donate poor people just use traditional banks?
- Q5. Why are microcredit interest rates so high?
- Q6. What are some of the ways that people use their microfinance loans?
- Q7. Why do you only lend to women?
- Q8. Does microfinance really help solve poverty?
- Q9. How do you know microfinance is making an impact?
- Q10. Where else can I find information about Microfinance?
Microfinance is the provision of financial services to the low-income customers often unreached by formal Banking sector. The term âmicroâ is in reference to the small amounts typically involved in the practice. Microcredit is the most visible and well-known microfinance service. Other equally important financial services include savings and deposit services, insurance, and remittance services.
These micro/ or very small size financial services make a very big impact at improving the income generating potential of economically active poor. Micro-credit is also useful in helping the low-income community indirectly avail services like healthcare and education for their children.
Poor people usually address their need for financial services through a variety of financial relationships, mostly informal. Credit is available from informal moneylenders, but usually at a very high cost to borrowers.
Traditionally, banks have not considered poor people to be a viable market. The products and services offered by Banks are not always considered âaccessibleâ and âconvenientâ to the customer mainly due to their service terms (no doorstep banking) and processing times.
Microfinance as an industry evolved in all the third world countries almost at the same time span. World over, it was getting widely recognized that improving income levels of low-income community is essential to improve their well-being â besides the state sponsored welfare programmes. During the 1970s and 1980s, the microenterprise movement led to the emergence of nongovernmental organizations (NGOs) that provided small loans for the poor. In the 1990s, across the world, a number of these institutions transformed themselves into formal financial institutions in order to access and on-lend funds, thus enhancing their outreach.
One of the significant events that helped it gained prominence in the 1970s was through the efforts of Mohammad Yunus, a microfinance pioneer and founder of the Grameen Bank of Bangladesh. In 2006, Prof. Yunus and Grameen Bank were awarded a Nobel Peace prize âfor their efforts to create economic and social development from below.â
In India, many formal financial institutional structures were experimented with â Regional Rural Banks (RRBs), District Central Credit Cooperative Banks (DCCBs), Local Area Banks (LABs), Self-Help Group (SHG)- Bank linkage programme. All these received mixed success and paralelly, the civil society organizations started feeling the need to offer financial services to the poor. Credit was getting increasingly recognized as an essential tool to break the vicious cycle of poverty.
Gradually, Microfinance Institutions emerged in 1990s and 2000s. MFIs today differ in size and reach; some serve a few thousand clients in their immediate geographical area, while others serve hundreds of thousands, even millions, in a large geographical region, through numerous branches.
Traditional Banks service a large client base with a large bouquet of products which includes many sophisticated products. Their systems and processes are very complex to support the requirements associated with their range of services. As a corollary, their processes become too complex for low-income people to comply with. Additionally, Banks are not able to service the customers at their doorstep. Therefore, if a low-income customer like a wage labourer has to access formal banking services, she/he would end up losing wages every time she/he needs to visit a bank branch to get loan disbursement, make repayment or access savings and drawals. Add to it the additional transport fare for the poor labourer. Effectively, the Banking system remains in-accessible to this customer segment. Therefore, even if a Bank branch exists, the customers would prefer to take loans from MFIs.
Internationally, poor people in developing countries usually do not qualify for any type of services from the formal banking sector: they typically have no credit history, and most are not employed in the formal sector, so there is no record of employment. Moreover, they are unable to provide collateral. Yet, people living in poverty, like everyone else, need access to financial services to help run a small business, manage risks, and plan for a more stable future.
This should be looked at from MFIsâ perspective as well as from clientsâ perspective. MFI Perspective â MFIs like any service provider need to offer financially viable services so that these can be sustainable unless these are subsidized. This involves cost of delivery of service to the customer doorstep such that the opportunity cost of customers on account of time is saved. The opportunity cost is the time they can use for improving their income, provide labour, get wages etc. From cost plus pricing standpoint, following are the three broad costs involved â
Operating cost [6 to 18%] : Depending on the operational efficiency levels of different MFIs, the range for operating cost is about 6% on the lower side for most efficient MFIs like Spandana â toâ Industry average of 12% while some of the MFIs have operating cost as high as 18%. Micro-financing involves large volume of small value transactions. Therefore the transaction costs are relatively high. Most of the Operating cost is the salaries of the field staff.
Cost of funds [10 to 14%] : Most of the money raised by Indian MFIs for lending is sourced from Banks in terms of loans. The industry average cost of funds is about 12%
Risk charge [1 to 2%] : To write-off bad debts and to provision against future delinquencies and any other risk, MFIs need to provide a charge into their Profit and Loss accounts
Considering the above costs, the average costs come at about 26%. MFIs typically add their margins to it and price their loans accordingly. However, Interest rate is not the only cost for borrowers â the other costs are also relevant, e.g if somebody is charging a high processing fee or any other fee should also be accounted. What is essential is to disclose all charges to the customers in a transparent and ethical manner.
Hypothetically, if the cost of funds from Banks goes down by 5%, MFIs can pass on all the 5% interest rate benefit to the customers â all other things remaining the same – and still maintain their service quality and profitability.
MFIs need to make margins to comply with the Capital Adequacy norms prescribed by the regulators and also to have enough accruals to support growth and reach out to larger number of clients who need similar services.
Client Perspective for clients, the mathematics is rather simple. They take a loan typically to employ in a productive business or to save themselves from extraneous costs or to improve their future opportunities e.g. funding a health event/ education. Typically the returns on investments that economically active low-income customers make far outweigh the costs associated with such loans. E.g. a micro-credit of Rs.10,000 (USD 222) can help such customers generate a return of over 3,600 by employing them in income generating activities. Therefore their sensitivity to interest rate is much lower than the timeliness of credit, availability of credit and terms of service.
The ways in which people use their loans vary as much as the ways people earn a living. Some of the broad usages are –
Increase investment in current income generating activity
Working capital, more equipment, more raw material etc
Start an alternative income generating activity (e.g. buying livestock)
Fund any cash-flow mismatch arising out of seasonal expense (e.g. school fee is paid in Month X while the harvests happen in month Y)
Retire a more expensive debt from a moneylender
A mix of above few
Poverty is a very complicated issue, and many different approaches and tools are required to address it. Microfinance is one such tool. It has worked for millions of the working poor to lift themselves out of poverty. However, microfinance is not the only answer, and in fact is not always the appropriate answer â for all poor and under all situations. For instance for the extreme poor, or those who are sick and/or unable to work, microfinance may not be an appropriate tool.
Microfinance as a tool to fighting poverty helps in increasing household income, which leads to ancillary benefits: increased food security, the building of assets, and an increased likelihood of educating oneâs children.
Microfinance is also a means for self-empowerment. It enables the poor, especially women, to become economic agents of change – they increase income, become business-owners and reduce their vulnerability to external shocks (loss of breadwinner, illness, weather, etc).
Microfinance is widely acknowledged to make a substantive impact in improving the economic conditions of the low-income households. To substantiate that, please refer to the following independent studies –
a) http://www.cgap.org/p/site/c/template.rc/1.26.1306/ Member states of the United Nations unanimously adopted the Millennium Development Goals (MDGs), a set of eight, specific, measurable, time-bound targets that challenge countries to improve the welfare of the worldâs poorest people. There is mounting evidence to show that the availability of financial services for poor households â microfinance â can help achieve the MDGs. Eradicate extreme poverty and hunger. Empirical evidence shows that, among the poor, those participating in microfinance programs who 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.
b)http://www.sidbi.com/Micro/impact.htm The overall hypothesis of Micro finance as an effective instrument for extending financial services to the poor and other under privileged groups by formal sector finance stands supported. Presumptions that MFI services reach those who have not yet accessed formal sector finance; MFIs’ outreach is generally focused on poorer areas; MFIs serve all castes and communities, majority of clients are women and micro finance has supported increased non-farm employment, have also been corroborated by the study. The study has highlighted the benefits received by the client households from their association with micro finance, in terms of livelihood activities, growth in employment opportunities, income generation, and access to various loan and savings avenues. Microfinance Practice helps in â
Improved access to credit and other financial services
Diversification of income sources
Improvement in income levels
Better employment opportunities
Building resilience in distress events
Improves decision-making of women in the household
Other positive socio-economic impacts: Number of meals per day, Health care, Purchase of clothing, Education and Seasonal migration.
c) www.responsAbility.ch By living up to the credit contract, poor people discover their own capacity to direct their future
d) http://www.unitus.com/news-and-information/features/impact- statement/Measuring%20the%20Impact%20of%20Microfinance.pdf As microfinance practitioners, we have witnessed the positive impact of microfinance first-hand.