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UNDERSTANDING MICROFINANCE

An Introduction to Micro-Finance
Up until around a decade ago, Micro-finance was associated almost exclusively with small scale loans to individuals and businesses in poor communities. Today it is used to describe a selection of financial products such as payments, savings and insurance, that are adapted to meet the needs of low income individuals, businesses and NGOs. Micro-finance also serves people who do not have access to typical banking services.
Micro-finance is also the idea that low-income individuals are capable of lifting themselves out of poverty if given access to financial services. While some studies indicate that micro-finance can play a role in the battle against poverty, it is also recognized that is not always the appropriate method, and that it should never be seen as the only tool for ending poverty

Poor people often do not have access to cost effective money-lending facilities and face having to take on often unaffordable fees and interest rates on loans available in their local community. This limits growth and development, puts additional financial pressure on low income families and serves to perpetuate the cycle of poverty.

Like borrowing, savings options for people in low income areas are only available through insecure and sometimes erratic schemes including credit associations, rotating savings and credit associations. Financial insecurity denies families and businesses the opportunity to develop suitably, limiting the incomes of entire communities.

Why don’t banks serve poor people?
Financial institutions were never intended to support those who don’t already have financial assets and to a large extent that remains the case, especially so in developing countries. Banks can make more money making large loans than small ones and the same is true for savings accounts.
This reality has started to shift in the past decade with some banks being established with the specific purpose of providing financial solutions to poor communities. Grameen Bank in Bangladesh and Bancosol in Bolivia are just two examples of financial institutions that were established to specifically benefit low income individuals, families, businesses and NGOs.

A number of different organisations have sprung up over the past ten years to fulfill this gap in the market. Ranging from NGOs and cooperatives to credit unions and self help groups which have provided new opportunities to people in impoverished communities who were previously unable to access credit facilities. As the market has matured and confidence has grown in the industry these new institutions have widened their portfolios to offer a diverse range of services from loans for children’s education to working capital for businesses and safety deposit boxes.

Families all over the world have grown to rely on remittances and money transfers sent home by friends and family, which these new financial institutions have enabled. In fact, income from family members abroad is one of the biggest contributors to economies in the developing world. Mobile banking or M-Banking has pushed the envelope even further by providing the most immediate and accessible method yet to manage your money, a service that provides a lifeline to people living in isolated areas.

A growing body of evidence supports the work of micro-finance organisations in developing countries. Appropriate and affordable financial solutions have been shown to help build household assets, generate income, reduce risks and increase consumption. Political and economic leaders have also sought to reaffirm the value of micro-finance institutions as a means of uplifting the poor and providing cost effective financial services. The people at the bottom of the pyramid have traditionally been the hardest to reach but new micro-finance options has worked to uplift some of the poorest people in the world.

According to the Consultative Group to Assist the Poor or CGAP, comprehensive studies in to the effectiveness of Micro-finance has demonstrated:

  • Micro-finance helps very poor households meet basic needs and protect against risks
  • The use of financial services by low-income households is associated with improvements in household economic welfare and enterprise stability or growth;
  • By supporting women’s economic participation, micro-finance helps to empower women, thus promoting gender-equity and improving household well-being;
  • For almost all significant impacts, the magnitude of impact is positively related to the length of time that clients have been in the program.”

Results from across the developing world showcase similar effects:

  • In Bangladesh, Bangladesh Rural Advancement Committee (BRAC) clients increased household expenditures by 28% and assets by 112%. The incomes of Grameen members were 43% higher than incomes in non-program villages.
  • In El Salvador, the weekly income of FINCA clients increased on average by 145%.
  • In India, half of SHARE clients graduated out of poverty.
  • In Ghana, 80% of clients of Freedom from Hunger had secondary income sources, compared to 50% for non-clients.
  • In Lombok, Indonesia, the average income of Bank Rakyat Indonesia (BRI) borrowers increased by 112%, and 90% of households graduated out of poverty.
  • In Vietnam, Save the Children clients reduced food deficits from three months to one month.”

The past decade and more of micro-finance development and penetration has created a world that even in some of the most deprived and isolated places on the planet, micro-finance has proven to support the poor on a sustainable basis, something that cannot be said for many other kinds of interventions, financial and otherwise.

The critical success factor in micro-finance services is simply whether clients have the capacity to repay the loan under the agreed terms. If people are unable to maintain these agreements such services can have the direct opposite effect with loaners situations being made substantially worse due to unaffordable payments. Therefore, micro-credit should be carefully evaluated against the alternatives when choosing the most appropriate intervention tool for a specific situation.