Microfinance for Dummies

Posted on March 29, 2010 in Business and Economy

Amiya Sinha:

The world today is moving 24X7. The rich are becoming richer and the poor even poorer (never mind the recession and the IPL bandwagon). Even though every country’s government claims to have borne fruitful results to bring in economic equality amongst its citizens, i.e. bridging the gap between the rich and the poor, the fact reamains that nothing considerable is taking place at the micro level or the grassroots. Microfinance has emerged as an effective poverty alleviation tool because it is based on the fundamental principle that human beings are motivated to do whatever it takes to make themselves as well off as possible.

Even though Economics may not make sense to a layman, but interpreting economic laws in layman language i.e. without all the technical terms, makes a lot of sense. The website Dictionary.com defines ‘Microfinance’ as, ‘a means of extending credit, usually in the form of small loans with no collateral, to nontraditional borrowers such as the poor in rural or undeveloped areas.’ Put simply, ‘Microfinance’ comes from two words, ‘Micro’ meaning small & ‘Finance’ meaning capital i.e. capital in small amount. A small firm or an economically unsound person will definitely need money, so ‘Microfinance’ is basically providing capital i.e. money in small amounts to people who require it to uplift their standard of living. More broadly, it is a movement whose object is “a world in which as many poor and near-poor households as possible have permanent access to an appropriate range of high quality financial services, including not just credit but also savings, insurance, and fund transfers.”

This approach was institutionalized in 1976 by Muhammad Yunus, an American-educated Bangladeshi economist who had observed that a significant percentage of the world’s population has been barred from acquiring the capital necessary to rise out of poverty. Yunus set out to solve this problem through the creation of the Grameen Bank in Bangladesh. The Grameen approach is unique because the small loans are guaranteed by members of the borrower’s community; pressure within the group encourages borrowers to pay back the loans in a timely manner. Using the provided money, the borrowers are able to start their own businesses or buy livestock.

There are several ways by which ‘Microfinance’ serves its purpose. Depending on the needs (read demand), Microfinance Institutions (MFIs) provide their services (read supply). The MFIs provide capital in the form of different kinds of loans, deposits and various insurance plans. Loans can be provided for emergency situations like paying off a moneylender or meeting a family disaster like sickness or crop failure. Moneylenders charge pretty high interest rates in villages and hence MFIs provide good alternative to them with lower interest rates. Taking an example, (source: Hindustan Times) In the slums of Hyderabad, where the average interest rate of non-MFI loans, when surveyed in 2007, was around 60 percent a year, borrowers can now borrow up to Rs. 10,000 from MFIs at around 24 percent. At the same time MFIs have managed to find ways to be financially sustainable and to keep growing fast. Work in many developing countries in terms of delivering to the poor; previous attempts to provide credit, through state run banks, for example, collapsed in the face of widespread corruption and defaults. Consider the story of Puja Patel, a single mother who lives with her four children in a village in India. With a Rs. 2500 loan, she bought a sewing machine. She made clothes, sold them for a profit, and repaid the loan with interest. She was also able to save some money to buy books and send her children to the local school. This is microfinance in action.

One question to ponder upon is, why might a poor person prefer a loan to a donation? This is answered by the very core principle of ‘Microfinance’- “The human dignity.” It is based on the old adage: “Give a man a fish; you have fed him for today. Teach a man to fish, and you have fed him for a lifetime.” Microfinance borrowers take great pride in their ability to lift themselves out of poverty through their own initiative. They work hard to survive from day to day and a loan provides a way for them to create a sustainable solution to their economic lot in life. A loan is attractive because microfinance borrowers know that successful repayment can result in the opportunity to take out more and bigger loans in the future. While a charitable donation can be helpful in the short-run, it may not represent an ongoing source of financial support. There are millions of poor people who live in the direst of conditions for whom donations are critical for survival. Microfinance does not target these people. It addresses a segment of the poor that are looking for a hand up, not a hand out.

‘Microfinance’ has potential in the years to come to uplift the status of the poor in the society. It has showed its credibility in Bangladesh, Bolivia and India in the past. It integrates the financial needs of the poor people of a country into the mainstream financial system. The 2005 national budget has further strengthened this policy perspective and the then Finance Minister, Mr. P. Chidambram announced “Government intends to promote MFIs in a big way. The way forward, I believe, is to identify MFIs, classify and rate such institutions, and empower them to intermediate between the lending banks and the beneficiaries.” Talking of India, Microfinance is still not at the centre of the financial sector. The knowledge, capital and the technology needed to address these challenges now exist in the country, although they are not fully aligned. With a more enabling environment and surge in economic growth (latest–India’s GDP was growing at 7.9 percent), the next few years promise to be exciting for the delivery of financial services to poor people in India.

‘Microfinance’ is one way for ensuring capital for everyone in the future. It will help the poverty stricken to rise from their grievous situation and bridge the gap between the rich and the poor. It has definitely showed its credibility in the past (in Bangladesh) and is one thing that is definitely poised for success in the years to come. By ensuring financial services to the poor at lending rates less than half of what are charged by moneylenders, MFIs give power to the people to uplift their economic status. In the coming years, ‘Microfinance’ will take a prominent role in the financial system of the third world countries and ensure economic equality for all.

Amiya is a correspondent of Youth Ki Awaaz pursuing Economics (1st Yr.) from Ramjas College, University of Delhi. Football is his religion and Manchester United is his god.  Writing has always been one of his areas of interest.