Microfinance

Microfinance is a term that is commonly applied to a wide variety of means of supplying small-scale loans to people who are unable to borrow from conventional sources, but particular attention has been given to the introduction of systems of lending to members of mutually-supportive groups. There has been a major growth in the provision of that category of microfinance during the 21st century and it is now used to supply various forms of finance to over 100 million poor people throughout the developing countries and in Europe, the United States and Japan, in small amounts totalling over $20 billion. Repayment rates have been generally high, but in some developing countries, the particularly rapid growth in it provision during 2004 to 2008 led to a shortage of well-trained administrators, and many people were allowed to borrow beyond their means. There are proposals to improve the regulation of microfinance and for its use in the creation of broader financial systems from which poor people are not excluded.

Definitions

There is no generally accepted definition of microfinance (of which as many as ten categories have been identified) but the term "Microfinance Institution" (MFI) is usually applied to an organisation that supplies finance to a group of borrowers, as distinct from organisations (such as credit cooperatives, rotating savings and credit associations ) that use internally-generated savings, and as distinct from organisations that lend to independent individuals. It is not uncommon, however, for members of a single group to use several informal sources of credit. The term is usually applied to the provision of credit, and is often referred to as "microcredit", but it is also applicable to insurance, money transfers and leasing. The term "Microfinance Investment Vehicle" (MIV), denotes a private sector entity which acts as an intermediary between investors and microfinance institutions (although some organisations are both MIVs and MFIs). The term "Inclusive Finance" has been used to refer to a future financial system from which the poor are not excluded, that includes or supersedes MFIs.

Microfinance Institutions

"Today the Norwegian Nobel Committee wishes to express its admiration for the work Muhammad Yunus and Grameen Bank have done for thousands upon thousands of ordinary people in Bangladesh and in many other countries. We hope the Peace Prize will be a source of inspiration in the continuing work for a world without poverty." Presentation Speech by Professor Ole Danbolt Mjøs, Chairman of the Norwegian Nobel Committee, Oslo, December 10, 2006[2].

The best-known microfinance institution is the Grameen Bank. It was launched in 1976 as the Grameen Project in the village of Jobra, Bangladesh, and was given the legal status of a bank in 1983. Borrowers hold 95 percent of its equity, and the rest is held by the government of Bangladesh. Loans are financed from deposits, without subsidies or contributions from donors. Every borrower must belong to a five-member group. Individual borrowing is monitored by the group, but responsibility for repayment rests solely on the individual, and is not legally enforceable. Collateral is not required. Loans average $120 and totalled $750 million in 2009. The interest rates charged to borrowers are 20 per cent for income-generating loans, 8 per cent for housing loans and 5 per cent for student loans, and interest-free loans are granted to "struggling members" (beggars). The interest rates paid to depositors range from 8.5 per cent to 12 per cent. The bank has over 8 million borrowers in Bangladesh, 97 per cent of whom are women. Its Grameen Trust also provides training, funds and technical assistance to replica programmes in other countries. By the end of 2010 it had supported 141 replication partners in 38 countries.

Other MFIs differ widely in size, scope, and source of finance. Some are financial cooperatives, funding their lending from members’ loans and deposits. Others have acted solely as intermediaries (termed microfinance investment vehicles) that channel funds from donors or from commercial sources. Some have developed from intermediaries into self-sustaining deposit-taking institutions, and some have formed ties with commercial banks. Some have achieved sustainability by serving borrowers that are above the poverty line, but those that have concentrated upon lending to the very poor have tended to remain dependent upon donations. Estimates of the number of borrowers worldwide range from 133 million (2007) to 190 million (2004.

MFIs operate in very nearly every developing country, and also in Europe , the United States, and Japan. Among the many sources of information about MFIs, the Microfinance Information Exchange lists 1800 MFIs in over 120 countries in Africa, Latin America and The Caribbean, East Asia and the Pacific, the Middle East and North Africa, Eastern Europe and Central Asia, and South Asia. The Economist Intelligence Unit publishes an annual in-depth analysis of the microfinance environment in 54 countries, including their regulatory frameworks, institutional development and the investment climates. Performance data for more than 1000 MFIs reaching over 85% of known microfinance borrowers are available from the Microfinance Information Exchange and information about interest rates is being collected by the MFI Transparency organisation

Sponsorship and funding

"The stark reality is that most poor people in the world still lack access to sustainable financial services, whether it is savings, credit or insurance. The great challenge before us is to address the constraints that exclude people from full participation in the financial sector…Together, we can and must build inclusive financial sectors that help people improve their lives." UN Secretary-General Kofi Annan, 29 December 2003, following the adoption of 2005 as the International Year of Microcredit

In February 1997, the first Microcredit Summit - a meeting of heads of state attended by 3,000 participants from 137 countries - agreed upon the objective of providing access to microcredit to 100 million of the world’s poorest families by the end of 2005. In July 2003 a meeting of the United Nations General Assembly adopted a programme of action for the International Year of Microcredit, 2005, and in 2005 the Microcredit Summit extended its target to 175 million by the end of 2015. The United Nations agency responsible for sponsoring microfinance is the World Bank.

A survey of 150 microfinance donors, investors and microfinance investment vehicles showed their total commitment to have reached $21.3 billion at the end of 2009. Public sector funds predominated , but there was also a substantial private sector contribution. A survey of 78 private-sector microfinance investment vehicles, showed their total investment in the period 2005-2009 as over $6 billion, of which $4.2 billion had been contributed to microfinance projects (the balance of their investors' funds being held in reserve as liquid assets).

Regulation

Microfinance institutions have to comply with national consumer protection regulations, and microfinance investment vehicles have to comply with national banking regulations. (The Financial Inclusion Regulation Center publishes links to regulator websites, and copies of banking and consumer protection laws, in about 30 countries.) However, existing regulations often fail to take account of the special character of microfinance, and banking regulators often lack the resources to effectively regulate microfinance. To remedy those shortcomings, sponsoring organisations have recommended the introduction of recognised and credible regulatory systems in order to retain the confidence of donors and investors. Agreed guidelines were published by the Consultative Group to Assist the Poor on behalf of 29 international donor agencies in 2002 , and the Basel Committee on Banking Supervision published a set of core principles in 2010, together with a survey of current practice. Regulations for the protecton of borrowers, including avoidance of over-indebtedness, transparent pricing, collection practices, staff behavior, redress of grievances, and client privacy, have been recommended by the Campaign for Client Protection.

Evaluation

There has been a widespread presumption that microfinance benefits the poor, and its rapid growth in developing countries (with an average annual asset growth rate during the period 2004-2008 estimated at 39 per cent) has been taken as evidence of its success. However, subsequent developments have raised doubts, and some of its previous advocates have changed their minds. It turned out that there had been little hard evidence of its benefits, and that much of what had been taken for evidence was, in fact, inconclusive. It was realised that comparisons between recipients and others did not lead to valid conclusions since some recipients may have been among the more enterprising members of the community - those who would have done better than the others without the help of microfinance. Studies using random samples had produced mixed results. A survey made 15 to 18 months after the introduction of microfinance in each of 52 randomly selected Hyderabad slums did not find any effect of access to microfinance upon health or education. Households wanting to go into business increased their spending on durables, but others borrowed to pay for day-to-day spending on non-durables. In his 2010 report to the United Nations General Assembly, its General Secretary has noted that, "...although the use of loans for such consumption smoothing can improve family welfare and capital, there is also the risk of creating debt traps". Repayment crises have in fact occurred in several developing countries, including Nicaragua, Morocco, Bosnia and Pakistan. An investigation of the crises in those four countries has identified one of the causes as borrowing beyond their means by people who can borrow from more than one MFI. Such "multiple borrowing" was attributed to the growth in the number of MFIs, combined with a tendency for several of them to target the same area. Other contributory causes were found to be a tendency for rival MFIs to compete by accepting bigger risks, and a deterioration in the quality of MFI management arising from the need to recruit staff in response to a rapid increase in demand. Among responses to repayment difficulties, there have been refusal to pay movements in Northern Nicaragua, and in the Punjab province of Pakistan, and rising repayment delinquency in Morocco and Bosnia. In his report to the General Assembly, the United Nations Secretary-General suggested that the impact of microfinance may be reflected less in income measures than in broader dimensions of poverty, such as access to health or education , and that it may reduce the vulnerability among people living in poverty by smoothing consumption and generating self-employment.