Microfinance

Microfinance is a term for the practice of providing financial services, such as microcredit, microsavings or microinsurance to poor people. By helping them to accumulate usably large sums of money, this expands their choices and reduces the risks they face. Suggested by the name, most transactions involve small amounts of money, frequently less than US$100.

History

The origin of microfinance is often dated as late as the 1970s. Only then, it is often argued, did any programs pass two key tests:

• show that poor people can be relied on to repay their loans, and
• show that it's possible to provide financial services to poor people through market-based enterprises without subsidy.

Recent evidence gathered by Timothy Guinnane, an economic historian at Yale, raises questions about this view. Guinnane demonstrates that the success of Friedrich Wilhelm Raiffeisen's village banking movement in Germany, which began in 1864 and reached 2 million rural farmers by 1901, resulted in large part from its ability to pass both these tests.

Guinnane shows how the village-based bonds of association of these early credit unions gave them both the information and enforcement advantages needed to make loans to people who were both too poor and too remote to access bank loans. Raiffeisen was moved to action by the poverty of the recently freed serfs, and by the degree of exploitation they faced from local moneylenders.

The caisse populaire movement founded by Alphonse Desjardins in Quebec, also met these tests. Desjardins and his wife Dorimène must have had strong faith in these principles. From 1900, when he founded the first caisse (which she managed), until 1906, when a law governing them was passed in the Quebec assembly, they both risked their personal assets for the liabilities of the entire movement..

Like Raiffeisen, Desjardins was concerned about poverty. But he was spurred to action by his outrage over usury. In 1897 as parliamentary reporter, he learned of "one notable [court] case in Montreal within the last few days, in which a man obtained a loan of $150, and was sued for, and was compelled to pay in interest, the sum of $5,000".

In the 1970s, a new wave of microfinance initiatives introduced many new innovations into the sector. Solidarity lending emerged as a distinctive new methodology, made famous by Dr. Muhammad Yunus at Grameen Bank.

The first fully-incorporated microfinance and community development bank was ShoreBank, founded in 1973 in Chicago.

Microfinance and development

Today, microfinance's major role is in the development of many African, Asian, and Latin American nations. The international year of microfinance celebrated in 2005 by the United Nations reminded people that millions worldwide benefit from microfinance activities, implemented usually by the United Nations and especially by the United Nations Development Programme. The countries where microfinance is most notable include Bangladesh, Bolivia, and Central African Republic. UNDP economist Davide Stefanini is at the forefront in these efforts in many developing countries.

Criticism

There is, however, criticism towards microfinance institutions. In 2001, a Wall Street Journal article raised questions about the Grameen Bank, including repayment rate, collection methods and questionable accounting practices.

On a larger scale, some argue that an overemphasis on microfinance to combat poverty will lead to a reduction of other assistance to the poor, such as government welfare.

Research on the actual effectiveness of microfinance as a tool for economic development remains slim, in part owing to the difficulty in monitoring and measuring this impact. Questions have arisen regarding whether microfinance can ever be as important a tool for poverty alleviation as its proponents and practitioners would submit.

Key debates

One key debate within microfinance has been whether donors and practitioners should focus on impact, i.e. improved living standards for the poor, or financial sustainability. The former approach has been called 'poverty lending' or 'the welfarist approach', whereas the latter is sometimes termed 'the institution-building' or 'financial system approach'. Whereas the welfarist approach often supplements financial services with other services such as education and health, institution-builders focus solely on financial service.

The arguments for this approach are:

1. if poor people are willing to pay to use the institution, it must be offering them value
2. only by ensuring financial sustainability can the huge demand be met
3. donors are best to direct subsidies to other services like education and health through separate non-profit organizations.

Examples of the welfarist approach are FINCA International, Freedom From Hunger, and Women's World Banking. Examples of the institution-building approach are Accion International and BRI Unit Desa.

Another key debate centers on the appropriate target group for microfinance services. One view is that the most important form of microfinance is credit targeted to poor people who are also talented entrepreneurs. If these people gain access to credit, they will expand their businesses, stimulate local economic growth and hire their less entrepreneurial neighbours, resulting in fast economic development. While this approach has had significant results in the cities of the developing world, it has failed to reach the majority of poor people, who are rural subsistence farmers with little, if any, non-farm income. As urban-rural income inequities continue to rise in the developing world, this result is increasingly viewed with dissatisfaction.

The World Bank estimates that of approximately 1.2 billion people who subsisted on less than US$1 a day in 2003, 850 million lived in rural ares. There is increasing recognition that poor people can and do save informally at home -- but lose much of their savings because home is a risky place to save. There is also recognition that before rural farmers will have the confidence to start businesses, they must be able to gain more control over other household risks such as hunger, disease and natural disaster. This requires access to safe, flexible small-balance savings accounts.

A new microfinance paradigm is taking shape, with the goal of developing full-service for-profit banks for all poor people. This approach is exemplified by the transformations at Grameen Bank (referred to as 'Grameen II') since 2000 and has been championed by practitioners such as Stuart Rutherford, Graham Wright, Madeleine Hirschland and Marguerite Robinson. The Consultative Group to Assist the Poor (CGAP) has also published extensively on the new microfinance. These banks will be able to support their clients' efforts to control family risks as well as capitalize on business opportunities. They will offer savings, insurance, remittance services, and personal and business loans, to help clients grow their assets while increasing their incomes.

External links

• Centre for Microfinance in India
• Directory of Development Organizations
• International Year of Microcredit 2005
• Microfinance Gateway contains research and publications, news, events and job listings for the microfinance industry.
• MIX Market provides financial information on microfinance institutions.
• Rural Finance Program at The Ohio State University
• United Nations Capital Development Fund
• Silicon Valley Microfinance Network (SVMN) northern california non-profit that profiles microfinance organizations & speakers
• microcapital.org The candid voice for microfinance investment