Introduction
Much of the developing world suffers from abject
poverty. Since the end of colonialism, numerous measures have been instituted
to try and alleviate this problem. Most of these initiatives have consisted of
providing cash, and less frequently, goods aimed at addressing the
socio-economic challenges facing the developing world. Yet, despite massive
amounts of aid being disbursed, these contributions have been largely
insignificant as drivers of sustainable change and growth. (Meier,G.M;
Rauch,J.E : 2005)
In recent years, an innovative approach to poverty
alleviation had, despite humble beginnings, gained traction. This approach,
known as microfinance, seeks to provide loans to those sectors of society who
are normally excluded from “mainstream” financial institutions.
Brief
Historical Overview
Microfinance (specifically, microcredit) began in
Bangladesh during the mid-1970’s. Bangladesh had been experiencing a terrible
famine at that time. Muhammad Yunus, a professor of economics found that the
“elegant theories’’ which he was teaching seemed to provide no answers to the
real world economic problems Bangladesh was facing. Yunus discovered that the
poor were unable to access credit at reasonable rates. The only credit
available to them was via money lenders and then at exorbitant rates of interest.
Yunus began to lend personal funds to villagers, allowing them to engage in small
scale crafts. In 1983, Yunus established Grameen Bank, whose sole focus was
lending money exclusively to groups of poor households, to establish
businesses.
In the subsequent two decades microfinance became the
proverbial darling of the developmental economic world. Microfinance schemes
were started, and experienced massive growth. Microfinance established itself
all across the developing world, from Morocco to Bolivia, Pakistan to Zimbabwe.
Developed countries too, quickly adopted the model including the USA and
Canada.
The mid- 2000’s saw the apex of microfinance’s
popularity. With 2005 being declared the UN “year of microfinance” and Muhammad
Yunus winning the Nobel Peace (not economics) Prize in 2006.
However, as microfinance grew in popularity, the model
also changed and eventually many Micro Finance Institutions (MFIs) began
engaging in the business solely with the profit motive. This led to substantial
structural problems which has resulted in microfinance schemes collapsing
across the globe. Microfinance has subsequently came under substantial and
vocal criticism and is no longer the “darling” of the economic world (Ghosh, J;
2013).
Functioning
Microfinance focuses on providing credit to those poor
who are excluded from the formal financial sector. These people are excluded,
primarily due to their inability to provide collateral. Collateral, of course,
is an integral component to the effective functioning of credit markets. Thus,
the challenge for MFIs was to create such a structure which allowed
uncollateralised financing whilst enabling a form of protection for the lender.
The structure adopted by Grameen Bank was to loan not
to individuals per se, but rather to groups of poor households. Groups are
formed voluntarily and all in that group are liable for repayment. Groups
consist of five individuals, with loans being provided in rotation to two
individuals at a time. Bank staff gather eight groups and meet with these 40
individuals on a weekly basis.
If any individual in a single group defaults, the
entire group is denied any subsequent funding.
This utilises societal pressure to enforce payment.
This can take the form of isolation or even physical retribution. By allowing
the recipients to form their own groups local knowledge is leveraged, as people
would only form a group with those whom they’re certain would be to their best
advantage. In this manner the risk of asymmetric information is mitigated.
By 1998, Grameen Bank had two million borrowers. The
bulk of whom (95%) were women. Repayment rates averaged 97-98%. The duration of
most loans is 1 year. At a nominal interest rate of 20%. However, at this interest
rate Grameen bank is not profitable and requires donations and other external
funding (Meier,G.M; Rauch,J.E : 2005).
A microfinance platform that has proven to itself to
be financially viable (without external donations) is the Bank Kredit Desa
system (BKDs) found in rural Indonesia. The key difference between this system
and Grameen Bank is the term structure of the loans. The BKDs, in 1994, would
disburse loans of around $71. The term of the loan would be between 10-12 weeks
(as opposed to Grameen’s yearlong loans). Furthermore, interest would be
payable at 10% of the principal on a weekly basis. This translated to a nominal
rate of 55% had the loan been for a year, far higher than Grameen’s
20%.The BKDSs method of allocation is
also different in application, adjusting for local mores, yet maintains the
same broad structural concept as Grameen, i.e. enforcement via social coercion.
The BKDSs method entails utilising Indonesia’s entrenched hierarchical system
to provide loans through the village-level management commissions which exist
countrywide. These commissions also mitigate asymmetric information and are
well positioned to ensure payment through social coercion.
(Meier G.M ; Rauch J 2005) have shown that out of the
5 major microfinance schemes only two make use of explicit group lending
contracts. However, all schemes make use of progressive lending, offer more
competitive terms than other lenders, and deny further finance to defaulters.
The schemes typically begin by providing a loan of a
small value. If this is repaid, a loan larger in value is provided. This
repeated process is known as progressive lending. This form of dynamic
incentive has a number of positive externalities including; the screening of
risky candidates, building long standing relationships with clients, creating
an anticipation within clients for forthcoming, larger loans if they pay the
smaller one.
Microfinance has also morphed into providing loans
almost exclusively to women, particularly in Bangladesh. This is due to their
exhibiting better fiscal responsibility compared to male borrowers.
A novel feature found in microfinance is the repayment
schedule. Repayments are due almost immediately after the loan is disbursed.
This in essence means that borrowers need a pre-existing income stream, which
implies that the loan is disbursed partially against an income stream. This
feature has several other advantages; undisciplined borrowers are screened out
early on, emerging problems are detected early on, the bank gains access to
cash flows before they’re consumed.
Feasibility
Microfinance suffers a severe defect as a business
form, that is, its general inability to attain profitability and financial
sustainability. By 2005, experts estimated that less than 1% of all had attained
financial sustainability, and that fewer than 5% would ever attain financial
sustainability
(Meier G.M ; Rauch J 2005).
For the microfinance model to work in a sustainable
manner, a rate of interest would need to levied that would prove to be almost
as high as that charged my traditional moneylenders. Thus, mitigating any
substantial benefits.
The remaining MFIs, who in fact form the vast
majority, are reliant on subsidies and donations to continue their operations.
In terms of sustainability, most MFIs have attained
“operational sustainability” where they are able to cover their running costs
but are unable to finance the full cost of capital.
Thus, microfinancing is quite clearly not the most
profitable of business ventures, but how does it stack up as a developmental
tool?
Meier G.M ; Rauch J
quoting Khandker; 1998 has demonstrated microfinance’s strength as a
developmental tool via simple cost-benefit ratios. These ratios are ascertained
by dividing the value of the subsidies by the benefit gained. He has reported a
cost-benefit ratio of 0.91 for women and 1.48 for men participating in Grameen
Bank’s microfinance scheme. This means that it costs society $0.91 for women
and $1.48 for every dollar of benefit. In comparison, the World Food
Programme’s Food-for-Work scheme had a cost-benefit ratio of 1.71 and 2.62 for
CARE’s developmental programme of a similar nature. Not all microfinance
schemes achieve a comparable result. The BRAC scheme sees ratios of 3.53 and
2.59 for men and women respectively.
The above factors indicate that microfinance is
largely unsustainable as a business model, yet may form a separate tool of
developmental aid. It should thus be viewed as such and compared with other
developmental schemes and not assessed as a business, in terms of financial
feasibility and sustainability.
Failures and Criticisms
In a recent 2013 paper Jyoti Ghosh has explained that
the microfinance model originally propagated by Yunus and Grameen Bank had
undergone a change, and that from the 1990’s onwards a paradigm shift occurred
where the emphasis of MFIs was towards “a full cost model”. This shift in focus
has led to substantial financial problems being experienced by the microfinance
sector, and in fact the collapse of the entire sector in several countries. In
fact, in trying to run MFIs as profitable businesses, their behaviour became
almost indistinguishable from “loan sharks’s” with exorbitant interest rates
being charged, unethical, violent coercive means being used to extract payment.
(Ghosh;2013) has also quoted substantial criticisms
from a diverse group of economists which have been levelled against
microfinance. These include; microfinance not being theoretically sound, in
fact being “built on sand”, to microfinance actually constituting a powerful institutional
and political barrier to sustainable economic and social development, and so
also to poverty reduction. This particular criticism is substantiated by
explaining that microfinance “ignores the crucial role of scale economies and
thereby denies the importance of large investments for development.’’ And also
“microfinance ignores the ‘fallacy of composition’ and adds to the saturation
of local economies by microenterprises all trying to do the same or similar
activities. Partly as a result of this, it helps to deindustrialise and
infantilise the local economy.” Another core criticism is that microfinance
funds have not been used for their intended developmental purposes, instead,
people have been acquiring microloans, claiming to use them to start up
businesses, whilst, in reality, these funds are used to fund consumption
spending.
These are
substantial economic arguments against microfinance. Besides these criticisms
aimed at the social effects of microfinance have also been levelled these
include; borrowers having to take on the supervisory, and penalising role of
lenders, social cohesion can be destroyed in the group monitoring process,
social hierarchies can become further entrenched, the self-selection of groups
has led to the poorest being marginalised and not being included in groups
(Ghosh; 2013).
Microfinance
in South Africa
Microfinance in South Africa has failed to live up to
its promise. Microfinance activities began in earnest in SA following the
demise of Apartheid. Yet, these activities have not resulted in any real
development. In fact, these activities have created a debt trap for the poorest
South Africans, many of whom borrowed money under the pretext of needing
capital for business purposes, yet they then used these funds for consumption
(Guardian;2013).
Lenders, had also contributed to this problem, by
lending recklessly, without substantial regulation.
Thus, in SA, microfinance had become a predatory
business. With large lenders chasing quick returns and development all but
forgotten.
Conclusion
Microfinance is certainly not the panacea to the
World’s developmental needs. It has the potential to be a tool of development,
if it is understood to be such. Thus microfinance needs to be measured in terms
of its cost-benefit ratio versus other developmental tools, understanding that
the model will work best as a developmental tool if it is subsidised, and then
the model with the best cost-benefit ratio should be chosen.
However, once
the profit motive becomes the overriding consideration, than the model opens
itself up to substantial abuses and the potential to become destructive, and
trap the poorest in a debilitating cycle of debt, indistinguishable from the
predatory “loan shark”.
References
Ghosh, J (2013), Microfinance and the challenge of financial
inclusion for development, Cambridge Journal of Economics
Meier G.M , Rauch J (2005) Leading Issues in Economic
Development, Oxford University Press
http://www.theguardian.com/global-development-professionals-network/2013/nov/19/microcredit-south-africa-loans-disaster
Accessed 30 August 2015
No comments:
Post a Comment