Aid – Microfinancing

In this session, we learnt about the difficulties associated with allocating aid and it made me think of a more bottom-up approach such as Microfinance and how that has affected development.

“Microfinance is most fundamentally the provision of credit without collateral, usually in relatively small amounts and for short periods of time” (Ghosh, 2013). The reason microfinance is possible without collateral to people who individually would not qualify for a loan is that individuals are grouped together and if one member of the group defaults the remaining members also suffer. Default in this case is minimised as people tend to monitor each other in the group to ensure everyone meets their repayments.

Microfinance and MFIs were very popular in international development during the 1990s but in recent times have fallen in popularity to the point they are proposed by some as ‘a poster child of exploitation of the vulnerable’ (Priyadarshee and Ghalib, 2011). Some critics attribute the poor reputation of microfinance programs to the change in their mission from reaching more people to alleviate poverty to a more commercialised financially sustainable business goal whereas proponents believe there is little evidence for this (Kar, 2016).  On the contrary, there are MFIs that have been very successful and increased their outreach and size such as the “Grameen Bank in Bangladesh and Bank Rakyat Indonesia in Indonesia” (Ahlin et al., 2011). Given the conflicting studies and conclusions, I decided to find a few solutions that have been put forward to improve the impact of microfinance. 

A study conducted based on a group of 104 slums in Hyderabad found that access to capital alone did not achieve the intended outcomes of microfinancing. “Consumption was still no different in treatment areas, and the average business was still no more profitable” (Banerjee et al., 2013).  Simply granting access to capital will not empower individuals to become more entrepreneurial. Instead, knowledge sharing initiatives should also be developed to help people utilise the funds in the best method possible for their individual circumstances. Smith, Judge, Pezeshkan, & Nair (2016) propose capacity building initiatives are required in subsistence economies in order to raise the successful impact of the loans received. This is further supported by findings by Bradley, McMullen, Artz, & Simiyu from Africa (2012).

This will however be quite difficult to achieve as most MFIs in developing countries presently face large transaction costs and lack internal capacity and expertise to promote such initiatives. Programs that provide MFIs with pro-bono profitability advice and skilled human capital must be encouraged in this respect.

Another major issue for microfinance is the oversight of MFIs. Since the inception of microfinance, there was a sharp incline in the number of MFIs and banks that provide microcredit around the world. This increase in competition made it difficult for some MFIs to manage the number of clients it was servicing and there have been reports that it even lead to cases of exploitative practices by MFIs to maintain market share (Microfinance in evolution: An industry between crisis and advancement, 2013).

In this case, an independent body that all MFIs report their client base and level of loans to would be beneficial. This would prevent other MFIs lending to clients who are indebted by other MFIs. This will also lead to further monitoring of MFIs to ensure an increase in the quality of portfolios. This is a very difficult solution to achieve in reality as most developing countries suffer from weak regulatory systems and this will place a greater strain on those systems.

References

Ahlin, C., Lin, J. and Maio, M. (2011). Where does microfinance flourish? Microfinance institutions’ performance in macroeconomic context. Journal of Development Economics, 95, 105–20

Kar, A. (2016). Measuring competition in microfinance markets: a new approach. International Review Of Applied Economics, 30(4), 423-440. http://dx.doi.org/10.1080/02692171.2015.1106445 

Banerjee, A., Duflo, E., Glennerster, R., & Kinnan, C. (2013). The miracle of microfinance? evidence from a randomized evaluation. St. Louis: Federal Reserve Bank of St Louis. Retrieved from http://search.proquest.com/docview/1698271053?accountid=8630

Bradley, S., McMullen, J., Artz, K., & Simiyu, E. (2012). Capital Is Not Enough: Innovation in Developing Economies. Journal Of Management Studies, 49(4), 684-717. http://dx.doi.org/10.1111/j.1467-6486.2012.01043.x

Microfinance in evolution: An industry between crisis and advancement. (2013) (1st ed.). Retrieved from https://www.db.com/cr/en/docs/Microfinance-in-evolution.pdf

Ghosh, J. (2013). Microfinance and the challenge of financial inclusion for development. Cambridge Journal Of Economics, 37(6), 1203-1219. http://dx.doi.org/10.1093/cje/bet042

Priyadarshee, A. and Ghalib, A. K. (2011). ‘The Andhra Pradesh Microfinance Crisis in India: Manifestation, Causal Analysis, and Regulatory Response’. Brooks World Poverty Institute Working Paper no. 157

Smith, A., Judge, W., Pezeshkan, A., & Nair, A. (2016). Institutionalizing entrepreneurial expertise in subsistence economies. Journal Of World Business, 51(6), 910-922. http://dx.doi.org/10.1016/j.jwb.2016.02.003 

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