Advantages And Disadvantages Of Microfinance 571d4p

Advantages and Disadvantages of Microfinance Microfinance presents many opportunities to the non-profit sector, but also comes with some qualities that make it a unique Form of philanthropy. Although the idea of microfinance seems to be a simple way of helping those in need, the actual paying Back of a loan and qualifications for a borrower make it a difficult to assess whether all markets are suited for microfinance. In the case of S2S, we will be communicating with established microfinance agencies to determine which groups are the prime Candidates to be borrowers. The following is an excerpt about the pros and cons of microcredit: "In the last two decades, substantial progress has been made in developing techniques to deliver financial services to the poor on a sustainable basis. Most donor interventions have concentrated on one of these services, microcredit. For microcredit to be appropriate however, the clients must have the capacity to repay the loan under the by which it is provided. Otherwise, clients may not be able to benefit from credit and risk being pushed into debt problems. This sounds obvious, but microcredit is viewed by some as "one size fits all." Instead, microcredit should be carefully evaluated against the alternatives when choosing the most appropriate intervention tool for a specific situation. "Microcredit may be inappropriate where conditions pose severe challenges to standard microcredit methodologies. Populations that are geographically dispersed or nomadic may not be suitable microfinance candidates. Microfinance may not be appropriate for populations with a high incidence of debilitating illnesses (e.g., HIV/AIDS). Dependence on a single economic activity or single agricultural crop, or reliance on barter rather than cash transactions may pose problems. The presence of hyperinflation, or absence of law and order may stress the ability of microfinance to operate. Microcredit is also much more difficult when laws and regulations create significant barriers to the sustainability of microfinance providers (for example, by mandating interest-rate caps). (http://cgap.org) I completely agree with this assessment of the advantages and restrictions of microfinance. Although it is a promising way to help global education and poverty, there are certain aspects to microfinance that make it unrealistic for some groups that are in need of help. Similarly, one aspect that was not brought up is the necessity for people who are easily accessible by a team that is on the ground in the area being helped. If a certain country has restrictions on who can enter and do what, it

may be difficult for our team to help the people there.

While microfinance can not reach all economic segments of society, it has been shown to reach segments previously un-serviced by oth - "Evidence of Microfinance's Contribution to Achieving the Millennium Development Goals", http://freedomfromhunger.org

Assessing the advantages and disadvantages of linking with M-PESA This note analyzes the advantages and disadvantages to both customer and financial institutions of linking with M-PESA. It concludes by describing consequences of the difficulties that financial institutions face with M-PESA. MicroSave’s recent research with fourteen financial institutions in Kenya revealed perceived opinions about advantages and disadvantages of linking with M-PESA. Findings indicated that:    

Banks, MFIs and Deposit Taking Microfinance Programs look for cost reduction, increased staff efficiency and customer convenience, which may lead to more transactions; M-PESA helps customers to cut costs, increase convenience and reduce risk of carrying cash by allowing them to transact their s from the nearest M-PESA agent, instead of travelling to a bank branch,; Financial institutions are facing difficulties in reconciling deposits initiated by M-PESA s to customers’ s; Banks are delaying informing customers that money has been credited to their ;



Customers are also finding it difficult to make withdrawals from a bank using the M-PESA channel.

Institutions that have agreements with M-PESA are not heavily promoting the opportunity, despite potential benefits, as a result of these difficulties. Financial institutions are looking for alternative arrangements to mitigate the challenges of linking with M-PESA.

The Limitations of Microfinance If you pay any attention to economic development in the third world, you have heard about microfinance.

It’s

the

hottest

thing

going.

Development

organizations

announce

their

involvement in microfinance with a kind of sacred hum. People are appropriately fascinated by the rise of Kiva.org, a website that enables you to engage in microcredit from the comfort of your

computer

chair.

Microfinance organizations offer financial services to people too poor to attract the services of traditional banks. They offer small loans—microcredit—and may also offer savings s, insurance, and fund transfer services. For example, I wrote a forthcoming article for Christianity Today Magazine about a wonderful Filipino group called CCT. The article features a woman named Cindy Caro who first borrowed $85, which she put into a processed meat business, selling hotdogs, sweetened beef and pork, ham and spiced beef door to door. Now she operates a small store. Some microcredit organizations place borrowers in small groups that meet together and guarantee each other, so that nobody can get a second loan until everybody in the group has repaid their first loan. Peer pressure and peer encouragement help borrowers stay on task. They are

less

isolated

and

less

prone

to

discouragement.

I’ve been amazed how many organizations have taken up microfinance. They all offer stories of families transformed by small businesses made possible through small loans—usually less than $100, at least to begin. Women buy supplies or equipment with these loans and (typically) make and sell food, leather goods, or clothing. Their profits enable them to send children to school, provide food for the family, improve their homes, and build an expanding business. Without question, microfinance is a wonderful development. Still, its quick rise to prominence, and its adoption by practically every last development agency, says a lot about how tough development is. They must not have had very effective tools, if they are all so eager to adopt this

new

one.

Microfinance promises to be something different—an approach that really does transform lives and communities. Here’s a short list of the benefits of microfinance:



–Taking out loans, buying insurance, and saving money all teach people how to be future oriented. Instead of living day to day, they have to think about their lives into the future, plan for the future, make sacrifices in anticipation of a better future, and work toward improved lives. This is the essence of capitalism. It is worth noting that development agencies that have historically had mixed feelings about capitalism are devoted to teaching small-scale capitalism through microfinance.



–Microfinance helps women. Almost all micro-borrowers are women, who develop home businesses. Women are generally more responsible than men, as any development worker will tell you. They use their profits to feed and educate their children, instead of blowing it on booze and gambling. In many patriarchal societies men control all the resources, and waste them. Microfinance gives women some power over their own lives, which they often use for the benefit of their families.



–Because many microfinance programs rely on peer pressure and peer , they promote community building and mutual ability. A culture of responsibility and encouragement can be built up.



–Microfinance programs can be self-funding. Some microfinance organizations even operate successfully as for-profit banks. For charities, there’s the prospect of investing once and moving on, rather than continually pouring resources into a bottomless pit.

However, microfinance has its limitations. This you won’t probably learn from the websites of development organizations.



–Microfinance helps women. That’s good, but not good enough to transform communities. Communities are formed of equal parts of men and women, who have a strong affinity for forming bonds with each other. Development that helps women but doesn’t involve men has a natural selflimitation.

You

can’t

men and women.

have

(For

transformational

more

on

this,

community see

development my

article

without ―Where

transforming are

the

Men?‖http://www.christianitytoday.com/ct/2005/august/23.41.html)



–Microfinance is small scale. True, small businesses become large businesses sometimes. But more often they don’t. A family may be greatly helped by the extra income from selling sandals at the market. Creating something larger, something that fully s the family and creates jobs, is rare. (This is probably one reason men don’t participate. They are attracted to larger enterprises outside the home.)



–Microcredit loans are expensive. Interest rates charged by microfinance programs are often over 20%. They have to be, because overhead is high for istering tiny loans. That means it’s hard for borrowers to make enough profit to really get ahead, after they pay loan costs. My friend Wachira counsels poor people to start with what resources they have or can borrow interest-free from family .

Certainly all microfinance organizations tell amazing stories of family transformation—and sometimes even of community transformation. When you hear those stories, though, keep in mind

what

I

call

developmental

cherry

picking.

In every community, whether rich or poor, there are a few people who are naturally curious, adventurous, and adaptive. Their lives may be indistinguishable from their neighbors’ because there have been so few opportunities in their community. But as soon as some outside force comes

into

the

neighborhood,

they

see

opportunities

and

take

them.

If you read missionary stories from earlier times you will often learn of such people. When missionaries came into their community the early adopters sent their children to the missionary school, they tried missionary medicine instead of traditional remedies (sometimes violating their own community’s strongly-held customs), and they adopted European agricultural methods. In these missionary stories a common plot development has to do with the difficulty of getting the rest of the community to stop persecuting these early adopters, but to follow their example. Similarly, when microfinance programs go into an Indian slum, they will unfailingly find people who seem to be waiting for just such help. They not only take loans, they build businesses. Their transformed lives make great stories, and since they appear just like other slum dwellers, it seems

as

though

microfinance

will

transform

other

lives

too,

as

it

spreads.

It’s not necessarily so. Others will take loans, which will help them augment their incomes, but microcredit won’t necessarily change their lives. As I understand it, research studies have yet to demonstrate the power of microfinance to alleviate poverty. There’s a big difference between transforming

early

adopters

and

transforming

everybody

else.

Which brings me back to an earlier point: development is tough. Where it happens on a large scale—in China, Taiwan, Korea, and Vietnam in recent decades, in Europe and America many generations ago—it is not brought about by agencies. There is some combination of opportunity (usually brought about by a decent government) and a widespread cultural mindset and mood. We don’t know how to develop those. Microfinance helps teach future thinking and planning, and that may contribute to a large-scale cultural shift. But nowhere is it written that alleviating poverty

on

a

small

scale

naturally

leads

to

community

transformation.

Our job is to help people in need. Microfinance is a good way to do it. But don’t think it’s the final solution. We’re still looking for that.

A main disadvantage to micro-finance is that the deal is too small for the lender to devote ample time and money to doing proper due diligence. As a result, default rates by borrowers are often rather high (witness Prosper.com). Borrowers seldom if ever give lenders the full story on their situation and with a small amount at risk, it does not make sense for lenders to spend a lot of money to check out the story. When lenders get burned, they decide to stop microlending and the next round of microlending must be done by greenhorns who have no idea what they are getting into. In other words, to some extent microlending depends on an ever-increasing number of lenders in order to be successful. As for alternatives, there probably aren't many. Microlending is a promising area and I am hopeful that sites like Prosper and Zopa can use their size to reduce the due diligence costs to a point where microlending can be profitable. Source: These are my opinions as a (former) lender on Prosper.com.

Disadvantages of microfinance? For whom? For the clients, it is probably the high interest rate, although the financial margin of small business in their risky environment are usually high and allow to afford the 20-40% annual effective interest rate. I do not see other downsides, apart that in competitive markets (e.g Peru and Bolivia), microfinance can introduce over indebtedness where it was not present before - to low income population. Alternative to microfinance? That's a weird question as microfinance is a broad definition of the development finance filling the gap uncovered by mainstream financial service providers (banks, insurance companies). For me, we need it as long as formal finance players have not completely stepped in these more informal market. Hope this answer will help you

Benefits and Limitations The benefits of microfinance are that it helps to manage the assets of the poor and generates income. Through microfinance institutions such as credit unions, financial non-governmental organizations and even commercial banks poor people can obtain small loans and safeguard their savings. The limitations of microfinance are that through this savings plan participants are losing money by having to pay a fee. The can also pay back their loans whenever they chose therefore encouraging a borrower to have various outstanding loans. The lender is also vulnerable in that there is no guarantee of the loan being repaid in the given arranged timeframe, and the consequences to defaulting are not defined. When looking at a micro-finance initiative, there are three main benefits and limitations for the model. These are based on a basic micro-finance initiative though they can be applied to many variations. When looking at the three benefits and limitations, they revolve around three key ideas, poverty, mistrust, and promoting change.

A micro-finance initiative wishes to address these issues in a positive way. For example, microfinance can be an alternative program to address poverty reduction where the tools needed to raise an individual or a family out of poverty are given to them directly. In a micro-finance project these tools include money primarily, and may also be accompanied with a savings program, and financial help. Along with poverty reduction, a micro-finance initiative can aim to avoid a general sense of mistrust between the citizens and their national banks. The money in this case, is not coming from a bank, but rather within the community which allows those participating to foster social capital and community cohesion. Lastly, a microfinance initiative can promote larger poverty reduction movements by increasing the financial knowledge of the average citizen. However, these initiatives are not without limitations. These limitations focus on the same issues as stated before, but the negative consequences that may occur. For example, while there may be mistrust in the national banking system, there can be microfinance initiatives where the outside creator takes advantage of those participating. The money may not end up in the right places, resulting in distrust to all who have interest in monetary programs, and could potentially ruin the chance of any further microfinance projects becoming successful. Secondly, when creating a microfinance project, time may be an issue. What happens when the program is finished and the people who were participating are still in poverty? In this case, it may be more beneficial for there to be an on-going program. To see what would be an appropriate choice in regards of time, the community must be assessed before the project is put in place. Lastly, in regards to limitations, someone is always going to be left out. Not everyone can be a part of the program, and therefore one must decide who is going to participate. Often, for a community development project to be sustainable, all must be affected positively. There are two ways in which the needs of the poor are not being met by micro finance. Firstly, the poor need to store savings for the long run; such as for their retirement, widowhood or their heirs but the examples such as saving up, down and through do not directly meet these needs. Secondly, the poor’s ability to save fluctuates with time and so they may not be able to save the fixed rate of saving. These two shortcomings are difficult for the poor and they often get excluded or exclude themselves (Rutherford, 2009). Poor people have to take a risk to turn their savings in to large lump sum of money because there is no perfect system that would protect their deposits. For example, there is a lack of trust among the and the organizer; most community micro finance projects only include family and close friends and do not reach beyond that. Also, there is no or very little growth in the amount of money that they save if saving up but if saving down, there is an interest rate that the have to pay. Also, there are complications associated with implementing micro-finance projects in Canada. For an example, inflation rates make it difficult to analyze interest rates across countries, so ASCA’s in high inflation would have to charge more interest on their loans which may result in their funds to decline in value themselves (Rutherford, 2009). In many countries, ASCA’s have become permanent

institutions referred to as Credit Unions, Savings and Credit Co-operatives. Rutherford argues that credit unions are not owned by the poor because they require specialized skills and higher educated personals to regulate the operation of these institutions themselves (Rutherford, 2009). Although these institutions aim to benefit the poor, they are very different from neighborhood ASCA’s and issues arise when they purse collateral or securities for loans given. Similarly, there are language barriers between formal federal banks and credit unions that causes complications (McMillian,2010). The major benefit of microfinance projects is that it allows low income families to save their money; most of the poor live day to day with the little money that they earn and cannot afford to save. Poor people need such alternatives in order to turn their savings in to large lump sums or receive large sums and pay monthly with low interest rates. Banks and other money lending institutions have high interest rates and simply won’t extend loans to poor people with little or no assets or employment. Microfinance helps the poor people get access or save funds over a period of time with low interest rates. Also, the poor could solve their own issues by working together as a community and this creates trust and social capital in their communities. It also leads to stability and growth in their households, as well as their communities.

Microfinance involves extending small loans, savings and other basic financial services to people that don’t currently have access to capital. It’s a key strategy in helping people living in poverty to become financially independent, which helps them become more resilient and better able to provide for their families in times of economic difficulty. Considering nearly half the world survives on less than $2 a day, microfinance is a vital solution. Here are six benefits of microfinance: 1. Access Banks simply won’t extend loans to those with little or no assets, and generally don’t engage in the small size of loans typically associated with microfinancing. Microfinancing is based on the philosophy that even small amounts of credit can help end the cycle of poverty. 2. Better loan repayment rates Microfinance tends to target women borrowers, who are statistically less likely to default on their loans than men. So these loans help empower women, and they are often safer investments for those loaning the funds. 3. Extending education Families receiving microfinancing are less likely to pull their children out of school for economic reasons. Assa serves tea in her grocery and snack shop in Nepal. Assa received skills training and a business loan from Plan.

4. Improved health and welfare Microfinancing can lead to improved access to clean water and better sanitation while also providing better access to health care. 5. Sustainability Even a small working capital loan of $100 can be enough to launch a small business in a developing country that could help the benefactor pull themselves and their family out of poverty. Watch Salamatu’s story of starting a rice-selling business in Sierra Leone. 6. Job creation Microfinancing can help create new employment opportunities, which has a beneficial impact on the local economy.

Criticisms Making microcredit facilities available to the poorest of society has attracted strong from neoliberals (because of its emphasis on individual responsibility) and those on the left of the political spectrum (because of its potential to empower women). ‘The basic idea sounds so simple and easy that a toddler could think of it. Why are people poor? Because they have no money. So let us give them money – then they will not be poor any more.’(Indian economist Jayati Ghosh) Although it would appear to be self-evident that providing finance for the poorest in society to invest in the means to increase productivity is a good thing for development, there is a problem when it comes to providing evidence of the benefits of microfinance programmes. There are very few evidence-based studies and those that have taken place only offer partial . The first randomized studies of microcredit appeared in 2009. MIT economists found that in the slums of the megalopolis of Hyderabad, India, small loans caused more families to start microbusinesses such as sewing saris. Existing businesses saw higher profits. But over the 12 to 18 months the researchers tracked, the data revealed no change in bottom-line indicators of poverty, such as household spending and whether children were attending school. (David Roodman, ‘Microcredit doesn’t end poverty, despite all the hype’, Washington Post, 8 March 2012) Microcredit has not had a positive impact on gender relationships A study in Bangladesh (2008) found that, although the majority of loans were made to women, they were often acting as collecting agents for their husbands. Women had to accept responsibility for repaying the loans that men had spent. This is particularly true for larger loans - women have 100% control over loans that are smaller than 1000 Taka but only 46% of control if the loan is bigger than 4,000 Taka. (Source: Lamia Karim, Demystifying Microcredit: The Grameen Bank, NGOs, and Neoliberalism in Bangladesh, a 2008 study of micro-lending) Interest rates are too high The cost of servicing loans is higher than for commercial banks because istration charges for small amounts are proportionately higher than for larger amounts of money. Institutions have to charge an interest rate that will cover those costs and continue to lend to future borrowers. The result is that the world’s poorest people pay the world’s highest cost for their loans. Grameen Bank interest rates are typically 20% but in other countries and institutions they can be much higher. The global average interest rate is estimated at 37%, with rates reaching as high as 70% in some markets. High interest rates are a major criticism and the high demand for the services of microcredit institutions is one of the major causes. The rapidly expanding demand for micro-lending encouraged institutions to look for capital from foreign commercial private equity providers. The non-profit models of the micro-lending institutions were in conflict with the private equity providers. As a result, many of them changed their status to for-profit in 2005, converting their philanthropic nonprofit assets into private for-profit assets.

One such micro-finance program was Compartamos in Mexico, which in 2007 launched an initial public stock offering. According to a New York Times article, it charged its borrowers an annual interest rate of near 90 percent, producing a return on equity of more than 40 percent, nearly three times the 15 percent average for Mexican commercial banks. This made Compartamos highly attractive to private equity investors. The public offering brought in $458 million, of which “private Mexican investors, including the bank’s top executives, pocketed $150 million.” (David Korten, ‘Microcredit: The Good, the Bad, and the Ugly’, Yes Magazine, 9 January 2011) For some people it is this neoliberal intrusion into micro-lending that has subverted a philanthropic ideal and caused many of the problems identified by critics. Others think that this notion is too simplistic and fails to take of other basic problems. Microcredit has driven poor households into a debt trap One of the impacts of high interest rates has been to force poor households into a debt trap. Households borrowing money have to earn more than the interest accumulating on the loan or face increasing debt. The previously mentioned 2008 study in Bangladesh found that some families were using a microcredit loan from one organization to meet interest obligations from another. Officials working for the microcredit institutions often had their own wages based on repayment rates paid by lenders and sometimes used coercion to collect repayments on loans. In some situations, instead of gaining release from the poverty cycle, families were driven deeper into debt. Microcredit does not alleviate poverty or improve health and education. Claims by some ers of microcredit about the contribution that microcredit can make to alleviating poverty are deemed to be unrealistic by many. One estimate by a researcher in Bangladesh suggested that 5% of the loans given by Grameen Bank resulted in the loanee escaping poverty – a worthwhile contribution to development but not the panacea that some people hoped it would be.