What are microfinance institutions
Microfinance - helping people to help themselves
The idea behind the concept of microfinance is not new and has been used in various forms for decades, especially in developing countries. So far - and still are in many parts of the world - private moneylenders were the primary source of money for poor people, who were denied access to traditional banks, mainly due to a lack of collateral and irregular income. But the often astronomical interest rates of private moneylenders often drive customers into a debt trap, which then often requires further loans. A way out is seldom in sight. Despite the existing demand for small loans and the fact that even extremely poor people can save and act responsibly with the money they borrowed, it took a few decades for the concept of microfinance to emerge. The reason for this may be primarily due to a lack of experience in this area at the beginning and the lower attractiveness of the business segment, since the offer of micro-financial services is usually associated with higher costs compared to standard financial services.
Despite this, the first official small loan programs started in the 1970s, the product range of which was then gradually expanded in the early 1990s to include savings and insurance through to transfer services for “little people”. The Grameen Bank in Bangladesh and the Self-Employed Women's Association Bank in India are considered pioneers of the microfinance movement. A sizeable market has now emerged and microfinance has become a sustainable business for many providers. According to a study by Deutsche Bank, there are currently 90 billion dollars in microloans in circulation with a total of 200 million micro-borrowers. The total revenues of microfinance institutions in 2010 were US $ 20 billion. The spectrum of providers now ranges from non-profit organizations to large commercial banks.
What exactly is microfinance?
The providers of microfinance services have gradually adapted to the needs of poor people over the years. The allocation of small and very small amounts of money is of course characteristic of microfinance services.
Traditional microloans are usually up to an amount of 1000 euros (source: Wiki Platform). The people to whom small loans are to be granted are “economically active” people, ie already small entrepreneurs or small entrepreneurs in spe. They apply for a loan and then receive a small amount that helps in many countries to build a livelihood by buying seeds, a means of transport or a machine and thereby break the cycle of poverty. With their additional income, the borrowers then pay back the borrowed money to the institution within a specified period of time.
The majority of borrowers are women as they are considered extremely creditworthy due to high repayment rates. Because of this, a large number of microfinance programs concentrate exclusively on female borrowers (source: world bank).
The loans are granted by actors from microfinance institutions, also known as implementation actors in emerging countries. They are trained on site and ideally should tailor the amount of the loan and the length of the term to the individual needs of the customer. In addition to individual loans, group loans, for example, can also be granted in which the repayment responsibility is shared among several people. The social pressure to repay the loan and thus make it accessible to the rest of the group replaces financial security with group loans.
Some providers use mobile sales representatives to ensure that people can also be reached in remote villages and communities for whom a trip to the next larger city is too costly. For some time now, more and more organizations have also offered micro-savings, educational loans and micro-insurance, in order to offer people long-term financial security. Because of this broad offer, one generally speaks of microfinance (source: Wiki platform).
The microfinance industry can be roughly divided into two main players. On the one hand, there are the non-profit microfinance institutions that do not act to maximize profits, but only want to cover costs, and on the other hand, the commercial microfinance institutions, which have made lending to poor people their business. The difference is that non-profit organizations only invest profits in the company or provide better conditions for their customers, but do not benefit personally from the profits. They have a social objective and often use the profits they generate or additional donations to offer training on economic management or educational measures in connection with microloans. In this way, they want to enable people to have a better life in the long term. There are a large number of institutions such as Kiva, MyC4, Oikocredit or Namaste Direct, which work with small businesses, schools and NGOs in developing countries and pass on small loans. In this way, private individuals can directly or indirectly grant their partners microcredits themselves.
In the meantime, however, many commercial microfinance institutions have also taken a liking to the system. These are mainly companies that operate in the microfinance business and traditional banks. One example is the Mexican microfinance bank Compartamos, which even went public in 2007 and raised the question of whether the poverty of some should turn into a profitable business.
Microfinance has now become a large market and, according to a study by Deutsche Bank, has an impact on the lives of a billion people worldwide. In addition to conventional loans for setting up small businesses, home loans, education loans and consumer loans are currently being granted. Most of the borrowers live in cities where the microfinance model works best (source: Deutsche Bank). Due to the higher demand for loans in cities rather than in villages where people know each other, the trend is towards individual loans. Nobody wants to bear responsibility for an almost foreigner, which means that the system of social pressure no longer works. The Grameen Bank seems to be an exception. In 2011 she looked after 8,349 million borrowers in a total of 2565 branches in 81,379 villages in Bangladesh. The bank thus covers 97% of all villages in the country and enables its customers - 97% of whom are women - to have access to their money almost anywhere.
The Shri Mahila Sewa Sahakari Bank in Gujarat India, founded by women for women, is also enjoying great success. From the Self-Employed Women’s Association (Sewa), around 4,000 women founded their own bank in 1974 after traditional institutions refused to provide them with funds for their businesses and purchases. What started with five employees has now developed into seven branches with 250 employees. The secret of their success lies in the close customer contact and the simplicity of the system. Sewa Bank, for example, developed corresponding images for each service, which are shown instead of the writing on the documents, and uses animal stories to explain the savings process. In this way, they ensure that every customer can manage their money wisely, even though many of the women cannot count.
Microfinance as a panacea?
After microloans were seen as the solution to poverty in the world for years and the chairman and founder of the Grameen Bank Muhammad Yunus even received the Nobel Peace Prize in 2006, the other side has been showing at the latest since the suicides in the Indian region of Andhra Pradesh the industry, which is characterized by the exploitation of borrowers and their spiraling debt.
In fact, the award of the Yunus Nobel Peace Prize in particular created worldwide hype and many new microfinance institutions sprang up everywhere. Quite a few of them deviated very far from the principles of the Grameen Bank in their motivation and concept, some even misused the basic idea for the exact opposite of the inventors of microfinance: While Yunus founded the Grameen Bank to take the usurers out of the market and take small loans To put it on the basis of cooperative thinking, others saw the granting of microcredits as a new business model, but with the idea of profit maximization.
The granting of microloans by commercial credit institutions is subject to completely different conditions than those of social enterprises or NGOs. On the one hand, this includes the fact that the amounts loaned are very small, but the costs for the credit organizations are very high due to poor infrastructure and additional training for employees and borrowers (source: World Bank). To cover this, the interest rates for the smallest borrowed amounts are at least 20%. Debtors have to generate enough money within a very short time with the help of the “cash injection” that they can pay off the loan plus interest and survive at the same time. Unfortunately, this rarely happens in reality (source: Max Planck Research). On the other hand, many people only take out the loans to ensure their survival and use it, for example, to buy groceries, pay medical bills or send their children to school. However, these investments create - at least no direct - added value and do not allow the debtors to pay off the loans. However, the pressure to repay the money on time is high (source: Max Planck Research). For example, some credit companies use hard means to secure the existence of their company through forced repayments. In addition, loan officers often work according to a bonus system, whereby they only earn when the money is collected.
The microfinance system is thus determined by many components whose possible negative influence can quickly lead to unsuccessful implementation. In addition, the long-term success of microcredit depends not only on the debtor's economic situation and the associated ability to repay the money, but also on the economic and political framework in the respective country. Instability, corruption and other unfavorable conditions increase the risk of small loans becoming a debt trap.
To prevent this, some institutions are already combining small loans with, among other things, educational measures. For example, Opportunity International Savings and Loans in Ghana offers training courses on how to do business in companies so that their customers do not leave them alone after the loan has been granted. And Activists for Social Alternatives supports women in India with help in the IT sector and also takes care of training opportunities.
The most important thing with regard to the granting of small loans is therefore to deal intensively with the needs and repayment options of customers and only grant them a microcredit if they also have the potential to pay it back. For buyers without economic activities, education loans or micro-savings programs are the better solution to help them out of poverty. Microcredit has proven to be most successful, especially for the lower middle class (source: Reinhard Schmidt). Although these are considered poor by EU standards, unlike many others they already have minimal financial security, which is why microcredits have small but positive effects.
This makes it clear: microcredits are not a blanket means of fighting poverty, but if they are granted carefully and ideally embedded in other measures, they are a possibility (among others) to help people in emerging countries to have an independent financial future.
However, there are still many tasks to be solved in order to enable more people to find a way out of poverty: A large number of the very poor people still have no access to an account or financial aid despite the tremendous developments in the financial system in emerging countries. The World Bank Report shows that in the sub-Saharan region, only 13% of people over the age of 15 have received benefits from a financial institution in the past 12 months. On the other hand, 40% borrowed money from family or friends. In South Asia only 9% did some sort of banking.
In order to include these people in the financial system, experts estimate new technologies as a possible means (source: World Bank). The mobile phone banking system M-Pesa is already an example of how money transactions can be made easily with the simplest means despite a lack of infrastructure. More on the subject can also be found in our article The cell phone as a development engine.
Sources and Links
The images used in this article were kindly provided by Christiane Ströh.
Rima Hanano I RESET editorial team (most recently revised by Henriette Schmidt I RESET editorial team 2014)
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