Microfinance 101

A friend of mine works at a law firm in London which does pro bono work for microfinance organisations. She, like a few others I know, want to know more about the intended and actual impacts that microfinance is argued to have in developing countries. Here is my take and some (hopefully) useful links to learn more… Please leave your own comments or other good links in the Comments section below…

The Basics

At its heart, microfinance tries to employ market-based principles to produce developmentally-progressive results. The guru of microfinance is a Bangladeshi professor called Muhammad Yunus, who started an organisation called the Grameen Bank. As the legend goes, around thirty years ago, Yunus came across a group of female basket weavers in his home country who were prepetually in debt because of the high interest rates that local loan sharks were charging them to buy the materials they needed. Unable to get out of debt, these women could never save enough money to invest more substantially in their craft business. Yunus sympathised and loaned them about 25 dollars to get out of debt; to his surprise, they quickly repaid the debt in full. This basic concept laid the groundwork for a concept which serves about 50 million borrowers and another 50 million depositors (with even more growth projected over the next decade).

In the beginning, microfinance worked a lot like a typical bank does, except with much smaller loans/deposits (most less than $100) and with alternative means for establishing collateral (because they don’t have any!). Loans are most often given to rural women who are assembled in small groups, whose collective credit rating depends on each of the members repaying their loans. This forces them to monitor each other and to help them out with business advice or support.

Since then, these microfinance concepts have been expanded to include the urban poor, HIV/AIDS and other sufferers, and even marginalised groups in the developed world such as immigrants and even schoolchildren. Still, the market is estimated to only be meeting between 5 to 10% of estimated demand.

But microfinance has also been challenged by some as a means of keeping poor people in debt or that it does not even reach the poorest of the poor (when these groups should simply be given humanitarian relief). The pressure to repay these loans has resulted in reports of suicides and continued patronage of loan sharks. In other words, it does not empower people but keeps them in a cycle of debt-fed poverty. Others argue that microfinance organisations have simply taken the place of loan sharks and formalised what used to happen on side streets and alleyways. Still others argue that the supposed gender impacts are negligible or even regressive.

Current Microfinance Debates and Trends

There is no doubt that the breadth of microfinance institutions (MFI) around the world has expanded in recent years. A noted example is the Mexican MFI Banco Compartamos which was just publicly listed and gave shareholders whopping returns while being accused of charging excessively high interest rates on its loans to poor people.

Simultaneously, mainstream investment banks have begun loaning increasing amounts of their money to MFIs in developing countries so that they have the funds necessary to grow more quickly. These banks get a set rate of return on their “big” loans (often less than their traditional loan rates) without having to do the work on the ground collecting all of the repayments/deposits and drumming up customers.

So is microfinance just like any other commercial activity or is it a developmentally progressive concept that happens to be market-based? Alex Counts, the current CEO of the Grameen Bank, argues that this is a “false choice”. It can be both, or neither, he claims. In a recent article in the Stanford Social Innovation Review, Counts argues that microfinance moves into previously untapped markets and helps deliver a number of financial, business, and social services to people who had previously not been reachable. Counts terms this microfinance benefit as that of a platform rather than a product. Thinking long-term and high yield (many users) but low margins (low profits per user), microfinance can get preferential regulatory treatment and develop trust in its users and in the general public.

My view is that — as with every growing industry — new microfinance propositions will emerge quickly, but the market will soon choose the “winners” among them and kick the cowboys out. As the industry matures, regulations will become more streamlined and this more easily monitored and reported. In a recent lecture I went to in London, Alex Counts sums up his view: “Microfinance is firmly rooted as non-profit but is just a fairly efficient way of promoting growth and jobs.”

For an overarching review of 90 academic studies of microfinance, check out Nathaniel Goldberg’s December 2005 article “Measuring the Impact of Microfinance: Taking Stock of What We Know”

For all things microfinance, check out: http://www.microfinancegateway.org/

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One response to “Microfinance 101

  1. Very useful insights. I’ve been looking at MF in relation to all areas of logistics …

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