Microfinance – does it work?
As the world struggles to find a ‘new normal’ for our financial systems, we take a look at an approach that has had some success, as well as some controversy.
‘Give a man a fish and he will eat for a day. Teach a man how to fish and you feed him for a lifetime.’ So goes the well-known proverb, but it is also the principal behind microfinance: Give a person a cash hand-out and they’ll have money for a limited time, give them a microfinance programme and they will become financially sustainable. Ok, so it’s not quite so catchy, but this financial approach has been hailed as a way to help people rise out of poverty.
But what does it involve and does it really work?
What is microfinance?
Microfinance aims to bring banking services to people that would otherwise have no access. This might be the unemployed or low-income groups, and is often focused on those living in poverty in developing countries such as India and across Africa. Globally, 1.7 billion people have little or no access to formal financial services that can help them increase their incomes and change their lives1.
Microfinance includes microcredit or microloans – sometimes as little as £100 – but it offers more too. People can access other financial services, for example insurance, savings accounts and financial or business training. This is ideally provided by organisations on a not-for-profit basis, with the aim of enabling economic self-sufficiency2. The benefits can reach out beyond the individual; a microenterprise started with microfinance can, in time, employ others and lead to a dynamic SME culture.
The concept of modern microfinance really began in 1974, when an economics lecturer called Muhammad Yunus at the University of Chittagong, in Bangladesh, decided to lend $27 to some villagers living in poverty. They paid him back, and a new model, of ethical and empowering finance was born, resulting in Yunus eventually being awarded the Nobel peace prize3.
How is microfinance accessed?
Microfinance began with non-profit organisations, but over time, the number of profit-seeking microfinance institutions (MFIs) has increased. Investopedia lists some of the largest and most influential MFIs4 as:
- 51Give – a non-profit organisation, collecting charitable donations and providing an e-commerce platform for other MFIs. As of 2020, they were being used by more than 100 charities.
- Bank Raykat Indonesia – 70% government owned, it provides small scale finance through thousands of branches throughout southeast Asia, on a for profit basis.
- Grameen Bank – the original MFI, linked back to ‘father of microfinance’ Muhammad Yunus. It has been for profit since 1983.
When microfinance turns bad
There is nothing fundamentally wrong with for profit organisations in the microfinance sector; it can result in more funds available for people to access if ethics remain at the heart. However, where there is cash, there is often corruption and some have sought to profit from this model of finance without an ethical approach, which has been to the detriment of those living in poverty.
As microfinance grew in popularity, reports began emerging of problematic practices. Where the demand for microfinance was high, checks were not carried out about a borrower’s assets and minimal support was offered to ensure that money was being put to productive use5.
More alarmingly, suicide rates soared amongst those who had accessed microloans. In 2010, more than 200 borrowers in the state of Andhra Pradesh, India, killed themselves. It is claimed that borrowers were verbally harassed, forced to pawn valuable items and publicly shamed. Allegedly, some were forced to drink battery acid if they were unable to pay back their loan. An independent investigation implicated market leader, SKS Microfinance, in seven of the deaths6.
There was also criticism of the high interest rates associated with loans – defended by providers because the transaction cost is high relative to the amount of money borrowed7. The positive buzz around microfinance was cut short, and it was claimed that banks were making excessive profits.
The industry responded with self-regulatory measures to improve the sector, leading to a Barometer of Microfinance aiming to analyse the impact of investments. Microfinance has continued to grow: In 2018, there were 139.9 million borrowers, up from 98 million in 2009. Of these 139.9 million borrowers, 80% were women and 65% were rurally-based8.
Just as in the charitable sector, the opportunity for damaging practice and dangerous mismanagement is inherent in a system that involves working with the most vulnerable individuals in society, but should this cloud our judgement of the merits of microfinance?
Can microfinance make a real difference?
Overall, the concept behind microfinance is attractive; empower and enable people to rise out of poverty. In practice, the opportunity for corruption exists. If avoided, does ethical microfinance really help?
A successful business depends not only on a cash injection and some sense of a business plan, but also on good health (reliant on sanitation, medical provision, food and clean water), basic education (numeracy and literacy), infrastructure such as roads, a reliable transport network and marketing support.
As Sam Daley-Harris, Director of the Microcredit Summit Campaign, explained, “Microfinance is not the solution to global poverty, but neither is health, or education, or economic growth. There is no one single solution to global poverty. The solution must include a broad array of empowering interventions. Microfinance, when targeted to the very poor and effectively run, is one powerful tool.”9
It is also interesting to note that because it is an optional programme, it is most likely to be taken up by those who are already entrepreneurial by nature, leaving the more cautious behind.
When delivered ethically, with adequate regulation and as part of a wider strategy, microfinance can provide exciting opportunities. Yet on its own, microfinance is not a golden bullet for poverty reduction.
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