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What is Microfinance?

MicrofinanceIn 2006, MIT Professor Muhammad Yunus was awarded the Nobel Prize for his work in the creation of the Grameen Bank. The Bank was created primarily to microfinance, or provide small loans, to the impoverished in Bangladesh. Today, over 97 percent of Bangladesh’s villages have a Grameen Bank presence, a whopping 7.5 million people have borrowed from the Grameen Bank and 65 percent of the borrowers “clearly improved their socio-economic conditions.” Yunus has even advocated for credit to be considered a human right because of the extent to which it can help people deal with their financial situations.

Prior to the emergence of this practice, the term “finance” largely carried the connotation of large banks, governments and corporations, and their respective handling of money or value. Liabilities, assets, savings, loans and other banking concepts can all be categorized under finance. So then, what exactly is microfinance?

Microfinance is the practice of bringing financial systems that are commonly used in the developed world, and applying these concepts on a much more personal and micro-scale. While we typically think of finance as a system that deals with large sums of money and organizations, microfinance is quite different because it deals with much smaller denominations of money and groups or individuals.

In practice, microfinance institutions or programs can differ in their specific models of operation. For example, Kiva is a microlending institution. It operates on donations, and any donor can personally become involved by browsing through testimonials and deciding whom to fund. On the other hand, the Grameen Bank no longer takes donations, and the Bank itself is actually 94 percent owned by the borrowers themselves. The majority of microfinance institutions deal primarily with microcredit, with most extending credit to women. About 97 percent of Grameen Bank’s loans are offered to women.

One point of criticism is the very high interest rates sometimes charged by various microfinance institutions; in some cases, the rate is over 50 percent. However, many argue that this is necessary to cover administrative and risk-taking costs. Defendants of the interest rates contend that participating in the loan program does not proportionately diminish the received benefits based on interest rate.

The benefits of providing financial services – often taken for granted – are unmistakably significant. The first benefit, as told by Mr. Yunus himself, is the mental and psychological stimulus a loan can give a person. The recipient of the loan becomes more independent and less inclined to feelings of marginalization. The second benefit is an increase in small businesses and economic activity in the villages. For some, small loans serve as the building blocks for small businesses. For others, the loans help pay for large goods or services like schooling, or healthcare costs, among other things. Providing small loans at affordable rates allows people to have more purchasing power than they might have otherwise, and to make purchases once considered not within their means.

An MIT study titled, “The miracle of microfinance? Evidence from a randomized evaluation,” was highly critical of the actual effects of microfinance versus the observed perceived effects before the study. Those conducting the study found that microfinance had some benefits for helping businesses increase profitability, and in increasing household income. They also found that household spending increased on durable goods, meaning goods that can be used more than once like cooking pots and mosquito nets. However, the MIT study found no significant changes in women’s empowerment, education or health. Finally, the study found that the adoption rate for microfinance was around 38 percent, indicating that many people still preferred to take out informal loans from other parties or family members.

Despite the critiques, microfinance has emerged as an innovative tool within the largely unchanging financial sector. By giving the impoverished access to financial services, the affected begin to have more opportunities and resources to turn to when dealing with personal or small business finances.

There are 2.5 billion people worldwide who are “unbanked” according to the World Bank. High costs, bureaucratic barriers and physical distance from banks facilitate this huge gap in the number of people with access to financial services and the total population. Microfinance has the potential to help bridge this gap by empowering the poor and providing them with more tools to help themselves. Although it may not be a miracle, it’s certainly better than nothing at all.

– Martin Yim

Sources: PBS, Kiva, Grameen Bank, MIT, World Bank
Photo: Flickr

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Mongolian Microfinance: Mercy or Menace

mongolian-microfinance-mercy-or-menace
Microlending began with the innovation of currency. Friends and family would get together and pool their money to offer help in times of hardship. Mary Coyle, director of the International Institute at St. Francis Xavier University in Nova Scotia, Canada, has found many such groups throughout history and around the globe, “In West Africa, they were known as ‘tontines;’ in Bolivia, ‘pasanaku;’ and across Mexico and Central America, ‘tandas.’”

The shift from microlending to modern day microfinance came about in the 1970s. Groups such as ACCION International in Venezuela and Yunus’s Grameen Bank in Bangladesh began to institutionalize the process. They formalized the loan process and expanded on already existing microlending practices. This enabled small businesses to generate capital instead of just paying for basic necessities.

With the initial success it has long been thought that microfinance was a long term solution to the problem of poverty. While it has brought some out of poverty, it has also kept others where they were financially before the loan and in some cases worse off.

In 2009 two studies were released on the use and impact of microfinance on those that were lent money, conducted by Karlan & Zinman in Manila and Abhijit Banerjee, Esther Duflo, Rachel Glennerster and Cynthia Kinnan of J-PAL in Hyderabad, India. Neither study found that key factors of poverty had been directly impacted, though it was established that those in the Hyderabad study shifted their spending from temptation goods to durable goods. Another study in 2010 by Duflo and Co. in rural Morocco found similar results. There was no major change in poverty, but those that already had businesses did diversify.

These results have done little to curb the continued lending of XacBank in Mongolia. XacBank reported to the U.S.-based nonprofit Microfinance Information Exchange total assets of 594 million dollars and a gross loan portfolio of 393 million dollars with approximately 77,345 borrowers. The company helped a Mongolian baker turn a 100 dollar enterprise into a 75,000 dollar operation. The company and its investors have touted that many people across rural Mongolia have been helped in such ways.

This was put to the test by research done by Orazio Attanasio, Britta Augsburg, Ralph De Haas, Emla Fitzsimons and Heike Harmgart. All are affiliated with London-based institutions: the European Bank for Reconstruction and Development, the Institute for Fiscal Studies and University College London. The study was a random selection of three rural villages across Mongolia. Loans were explained, applicants were screened as individuals and groups and then finally money was offered. Only 50 percent of those offered loans took them.

The findings were in line with the three previous studies. “Although the loans provided under this experiment were originally intended to finance business creation, we find that in both the group—and in the individual-lending villages, about one half of all credit is used for household rather than business goals. Women who obtained access to microcredit often used the loans to purchase household assets, in particular large domestic appliances. Only among women that were offered group loans do we find an impact on business creation.”

With such little change in the poverty rate, some wonder why we would continue this trend of microlending. It has proven to help some, but the vast majority either can’t access the funds or are turned down due to credit issues.

Hope comes from the Norwegian Nobel Committee, when they spoke of Yunus and his work: “Yunus’s long-term vision is to eliminate poverty in the world. That vision cannot be realized by means of microcredit alone. But Muhammad Yunus and Grameen Bank have shown that in the continuing efforts to achieve it, microcredit must play a major part.”

– Frederick Wood II

Sources: UNDP, NY Times, MicroCapital, The World Bank, Center for Global Development, NPR, PBS
Photo: Bloomberg Business Week

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Jeopardy’s Bob Harris Writes About Microlending

Jeopardy’s Bob Harris Writes About Microlending

For many fans of Jeopardy, the name Bob Harris is synonymous with knowing things. Because he’s a thirteen-time champion of the game show and general outspokenness, many respect his opinions. Thus, his new book is making waves in the literary community and may initiate some important dialogue about how to deal with international poverty.

It all began when Harris, a writer and radio commentator by trade, was given the opportunity by ForbesTraveler.com to review some of the world’s finest luxury hotels. However, instead of simply pocketing the earnings, Harris decided to lend the money via kiva.org while continuing to travel around the world to take a look at all the lives that the money had affected. His experiences were compiled into a book titled The International Book of Bob. The book, in addition to shining a light on microlending, shows the juxtaposition of the world’s wealthiest and poorest people. Harris writes of ATM machines that emit gold ingots and Asian construction workers who live like indentured servants in Dubai for the chance to send money back to their families.

In an interview, Harris explains the fundamentals of microlending:

“Microlending was pioneered more than 30 years ago by, among others, Muhammad Yunus and the Grameen Bank in Bangladesh. Charity certainly has its place in poverty alleviation, obviously — when there’s been a disaster, or when there’s epic need — but in many places, the people have small enterprises, and they know what they can do to solve their own problems. They’re in the middle of their businesses and they simply need a small loan.

But if you’re a fisherman, and you simply need to patch a hole in your rowboat, you can’t go to Citibank for a bridge loan in Cambodia. So who do you go to? Prior to microlending, your alternative would be maybe leaning on your family or villagers, or going to black-market money lenders, and paying an exorbitant interest rate. When you go to kiva.org, the vast majority of donors are finding people on the website to whom they can put $25 toward a loan; that money goes overseas to a local lender and the recipients pay the loan back, then you get paid back.”

Speaking once again about kiva.org, Harris says “Now there’s this place on the Internet — where total strangers go, to be nice with other total strangers so they can all collectively be generous to yet more total strangers whom they will never meet — and somehow my name is in the middle of that. That’s magical.”

– Samantha Mauney

Source: Huffington Post
Photo: Telegraph

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