The Microfinance Conflict and Future Prospects – Part 1

According to United Nations reports, more than 800 million people around the world still live in extreme poverty. A major portion of India’s population indisputably contributes to this figure. These individuals often engage in small scale businesses where obtaining monetary benefits is an area of grave concern. They are often deprived access to financial resources from conventional monetary institutions. This subsequently leaves them at a disadvantage in their business. Therefore, the field of microfinance emerged as a strong intervention tool to tackle this capital shortage crisis that exists in the rural sectors of society.

Microfinance is a banking service that allows small scale business owners and individuals with extremely low-income to engage in productive activities to nurture their small scale businesses. This is encouraged by allowing these individuals access to capital through loans, insurance policies, money transfers, credit savings, etc.

Emergence of Microfinance

The concept of microfinance emerged in the early 1980s in the village of Jobra, Bangladesh. Economics Professor, Muhammad Yunus observed that the village suffered from several critical issues including failure of the free market and banking sectors, famine, poverty, etc. Understanding that some form of action was required, Professor Yunus began to deliver personal loans to a group of 42 women to help them begin a business. These women utilized this opportunity to boost their productivity in their bamboo stool business. This process of combating poverty through microcredit, established the basic principles of microfinance.

Determined to expand his concept, Professor Yunus soon began his own microfinance program, known as Grameen. This program offered small loans to the poor, with no financial guarantee required in return. It also promoted the principle of joint responsibility which required solidarity between the members of the beneficiary groups. By 1983, the program obtained the status of a banking establishment. Grameen Bank, also known as ‘Bank For The Poor’, now operates successfully in over 80,000 villages. Studies suggest that this initiative has supported nearly seven million individuals. Among these, 97% were women.

Professor Yunus ignited the spark of an extremely salient industry. By the 1980s and 1990s, full-fledged microfinance industries began to emerge in developing countries including India, South America, Europe and the Mediterranean basin. The first microcredit summit took place in 1997 in Washington and in 2004, microfinance emerged as a new economic sector. For his honorable initiative, Muhammad Yunus won the Noble Peace Prize in 2006.

Microfinance and Holistic Rural Development

Microfinance has often been mentioned as an important instrument to combat poverty. According to the Nobel Committee, microfinance can help people break out of poverty, which is considered an important prerequisite to maintain everlasting peace. However, whether microfinance has managed to significantly alleviate poverty, is an area of conflict.

Many studies have indicated that poverty can be alleviated by stimulating economic growth through microfinance. Using panel data from Shahidur Khandker’s work in Bangladesh, an insight into the impact of microfinance on poverty reduction for both borrowers and the society as a whole was analyzed. The results suggest that access to microfinance contributes to poverty reduction, especially for female participants, and to overall poverty reductions at the village level. It also has various spillover effects including schooling, a rise in awareness of reproductive health issues among poor families, asset building, etc. Another study conducted in rural Nigeria also indicates that the implementation of microfinance did result in increased schooling of children, improved the nutritional status of individuals and also led to better housing. Therefore, the welfare gains have improved.

The birth of SHARE (Society for Helping Awakening Rural Poor Through Education) by M. Udaia Kumar in 1989 in Andhra Pradesh was another successful product of microfinance.
This institution provided microfinance services such as credit and savings to the rural population of Andhra Pradesh. SHARE is a unique institution that is managed only by poor women. Post conducting a study on its clients, it was analyzed that 64% had been labeled as Very Poor when they became members of the institution. However, after 4 years only 7.2% of its members were considered very poor.

Therefore, it can be interpreted that microfinance has contributed to uplifting the rural sector in certain ways. An increase in income, accumulation of assets, reduction in the vulnerability to diseases, a fall in the occurrences drought and crop failure, better education, health, and housing are some of the benefits of the microfinance program available to the borrower. Furthermore, microcredit has also contributed to improving the social and economic situation of women.

Loopholes in Microfinance Operations

Notwithstanding the positive effects of microfinance, many scholars have presented their arguments on whether microfinance has substantially contributed in reducing poverty. Many studies indicate that microfinance does not reach the poorest of the poor, or that the poorest are deliberately excluded from the microfinance programs. Multiple times, the extremely poor do not borrow due to the fear of the risk involved in the process. Often, they are also not accepted in the group lending programs because they are viewed as bad credit risk. Staff members of microfinance institutions may also prefer to exclude the core poor since lending to them is extremely risky.

Additionally, the element of group loans in the microfinance program often poses several obstacles in the efficient alleviation of poverty. Often, the size of the needed loan exceeds the maximum amount that can be borrowed in terms of group loans. Since group loans are rigid, it is difficult to adjust the loan to the desired credit needs of the individual borrowers within the group. Moreover, group loans also demand group meetings which results in high transaction costs.

Another major obstacle of microfinance is the disadvantage faced by women. Research indicates that women are more reliable and have higher payback ratios. Moreover, women use a substantial part of their income for the health and education of their children. Thus, women largely contribute to reducing poverty within households. However, critics argue that women are often forced to hand over the loans to men, who subsequently use the loan for their own purposes. This may lead to an additional burden for women if they are held responsible for repayment.

Researchers often also face methodological issues due to which a coherent conclusion on the poverty alleviation situation may not be inferred. Many studies often neglect the issues of self-selection and nonrandom program placement. This then leads to biased estimates and conclusions on the impact of credit on poverty. Self-selection bias affects the estimates of program benefits because households with more entrepreneurial capability are more likely to join the programs. Similarly, non-random program placement may also be problematic if programs are implemented in those areas that have more business opportunities, better communication infrastructure, and where more dynamic leaders are also poorer.

Need for Intervention

Certain measures can be adapted to improve the functioning of microfinance sectors around the world. Firstly, governments should amend the regulations which determine the caps on interest rates and allow the MFIs to set appropriate rates. If the rates are too low, it restricts the institution from attaining financial sustainability and providing additional capital. Secondly, it has been argued that too much focus is laid on only providing loans to the poor. Additional services including savings and insurance must also be encouraged. By providing them with a savings account, it allows these individuals to save for critical situations. There also has to be better monitoring and evaluation of micro-financial institutions to ensure optimal efficiency.

Therefore some view microfinance as the ideal tool for eliminating poverty around the world as it has the power to bring financial power to the individuals that require it. However, others question the entire concept. Multiple times, the positive or negative effects are region, district or state-specific.

In the past 25 years, microfinance has been considered as one of the most significant interventions in development policy around the world. Microfinance not only offers microcredit but also allied services such as consulting and training for microenterprises. Moreover, it has intensively helped in uplifting women and promoting the social and economic conditions of both men and women. Like most endeavors, microfinance too has its limitations. However, with efficient intervention by the respective authorities, the problem of achieving self-sufficiency and its goal to expand its outreach and impact can be resolved. Overall, microfinance has shown substantial results in alleviating poverty in rural areas.

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