Micro Finance Institutions in Pratice

8/4/2019 Micro Finance Institutions in Pratice

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Student No: 1059936 Development and Transition Project

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University of Warwick

MSc Economics and International Financial Economics

Development and Transition Project

Student No: 1059936

MICROFINANCE INSTITUTIONS IN PRATICE

To what extent does Microfinance work? Does it fulfil its primary goal?


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Introduction

Poverty alleviate in the Developing World has become a priority with the need to provide

sustainable income, and the fulfilment of basic social, health and literacy needs amongst the

poorest of the world. To help fulfil this need microcredit has spread rapidly since its inception in the

1970s, however, the extent to which it helps the poor is a subject of intense debate. Microfinance

Institutions (MFIs), offers poor and vulnerable people access to basic financial services such as

loans, savings, micro-insurance, training, and peer support. These loans although provided with

high interest, MFI programs have shown that poor people achieve strong repayment records - often

higher than conventional borrowers.

Consultative Group to Assist the Poor (CPAG) lists some of MFI goals as - poverty eradication,

education, gender equality, women empowerment and health improvement.

With Poverty Alleviation as the primary goal, this project focuses on analysing the impact of MFIs

in achieving this. A wide range of research has been conducted on developing countries in order to

assess the effectiveness of these institutions on this topic. The critical analyses of this project will

aim to answer the following questions:

To what extent does Microfinance work?

Does it fulfil its primary Goal?

First, I will assess the empirical work of Banerjee.A, Duflo.E, Glennerster.R and Kinnan.C (2009).

Other literature will be used to discuss and limitations.

Empirical Research

Banerjee et al (2009) discussed on The miracle of Microfinance based on randomized evaluation

assessing the effect of canonical group-lending micro-credit model. In 2005, 52 of 104

neighborhoods in Hyderabad were randomly selected for the opening of an MFI, while the

remainder of the sample was left out.

This paper considered the effect of MFI on potential new and old business owners, and people with

a low propensity to start business. The aim was to examine the effect on outcomes that directly

related to poverty such as consumption, new business creation, income, education, health and

womens empowerment.

The results suggest that access to microfinance contributes to overall poverty reduction in the

sample areas, with no improvement in health and education

These conclusions raised questions on the evidence of microfinances impact in alleviating poverty.


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The Poverty Trap

The paper raises a question on the sustainability of microfinance resulting from the criteria for loan

selection. The analysis showed that potential non-business borrowers spent a significant proportion

of the loan received on non-durables, temptation goods and other loan repayments. The criteria of

giving out MFI loans for non- business purposes raises questions on how these loans aim to

alleviate poverty in the long run. When such loans are issued, doesnt this alleviate poverty only in

the short run? How are these loans expected to be financed with interest in the long run? With such

loans given out often, isnt there a question of keeping the borrower in a Poverty Trap, hence only

limiting the impact of MFI to the short-term.

CPAG stated that, While many poor people can benefit from a microloan, not everyone should

receive or can use credit. Providing credit to those not able to use it productively could push

already-vulnerable people into debt. This argument may also be valid in assessing these loans

further. Evidence provided these loan expenditure patterns with no expected return / business

investment explains that prolonged lending by MFI of such loans may only lead to a poverty trap

from debt in the long-run.

Furthermore, this is also supported by evidence from other loan categories. Loans given to potential

new and old business owners, gave evidence of better results on non-durables, durables and

temptation goods, compare to non-business loans. Consequently, if business investment loans

achieved better results, then this poses a question of the effect on poverty alleviate from MFI non-

business related loans.

With evidence from Nepal, Sharma.P.R (2004) in explaining the effect of MFI on poverty

transformation, discussed the numerous programs implemented for poverty alleviation with only

MFIs seen as a poor targeted rural based program. However, the provision of these loans is not

fully covering the poorest of the poor and vulnerable. This shows that popularity of MFIs has

increased greatly, however, with questions on its impact for alleviating poverty.

Loan repayments Borrowers

There is also a question of the effect of loans on the borrowers. MIFs operate a system of dynamic

incentives when they increase the amounts lent to a specific borrower as credit is renewed, and

condition the allocation of new loans on previous repayment behavior. Evidence shows that as

loans are renewed to previous borrowers there is a higher probability of default in the long run.

In a study on the Grameen Bank, Khandker, Khalily, and Khan (1995) found that the longer the

MIFs operate in an area, the higher the loan default rate. They explain this feature by the possible

decreasing marginal profitability of new projects. This could also be due to a deceasing power of


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dynamic incentives as credit is renewed over time especially if borrowers observe that credit is not

systematically denied to defaulting or late borrowers. Khandker (1995) however, found that

membership training, which relates to nonfinancial services, had a positive influence on repayment.

Where there are problems with these loan repayments in the long run, there is a reason of concern

for MIFs only providing short-term relief from poverty, leaving the poor in a poverty trap in the long

run.

M.Godquin (2004) also deducts questions on loan repayment based on individual versus group

loans. With evidence from Zimbabwe, Bratton (1986) states that group loans perform better than

individual loans in years of good harvest and worse in drought years when peers are expected to

default.

Temptation Goods

Banerjee et al explained that MFIs sometimes claim that that access to microcredit may reduce

consumption of temptation goods such as such as alcohol, tobacco and lottery tickets. However, old

business owners do not reduce their consumption of these goods as much as new business

owners. Doesnt this suggest that this low consumption of these goods by new entrepreneurs is only

temporary due to fixed-cost investment? The slightly higher expenditure by old entrepreneur may

suggest that once new businesses owners start to yield returns on investment, patterns of

consumption in temptation goods may increase to similar old entrepreneurs level. Hence this

argument implies that the reduction in the consumption of temptations good may only be atemporary impact from MFIs and not a permanent impact on poverty.

Sustaining Poverty Alleviation

The Microcredit Campaign Summit (MCSC) explains that in addition to loans, MFIs can also provide

nonfinancial services in the form of training and financial education to Borrowers. Banerjee et al

(2009) doesnt discuss about such MFI services. However, evidence has shown that in order to

provide the efficient and sustainable use of loans to the poorest and vulnerable of the world

(particularly women), these nonfinancial services are important. These services may result in better

outcomes and a sustainable way to alleviating poverty.

M.Godquin (2004) explained that in addition to loans, some microfinance programs are also

referred to as credit plus (Edgcomb & Barton, 1998; Zohir et al., 2001). These programs provide

services (such as health services, adult literacy and training) which go beyond financial services.

This microfinance methodology has little evidence documented.


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In addition, evidence is also needed on the best institutional way of providing these services to

improve the effect on borrowers: should they be provided by the MFIs or should the MFI operate in

partnership with NGOs providing these services?

There is also a question for the sustainability of these businesses set up by MFIs. From Banerjee et

al, there is contrasting view between the proportion of new loans invested by new business owners

and re-invested in the business by old business owners. The split between current consumption and

partly in business varies especially for old business owners, raising a question of the sustainability

of MIFs in influencing sustainable poverty alleviation or possibly pushing the poor into a long-run

poverty trap. A possible solution may be a review of the structure of MIFs, possibly if stricter

regulations were put in place, specifying that a larger percent of loans to existing business owners

must be re-invested in business. This then could improve the impact of MFIs in the long run.

Health and education

MFIs may succeed in creating and expanding businesses, however, in order to totally eradicate the

poverty trap in the long run, it is important that MFIs show evidence of affecting education and

health. Banerjee et alexplains that MFIs appear to have no apparent effect on education, health, or

womens empowerment. However, this does not consider the long-term effect on the sample period,

when the loan and investment impacts would have translated into returns for households. It is

possible then that impacts on health and education would emerge in the long run. Overall, in theshort run, MFIs do not appear to be a formula for education and health improvement.

Banerjee et als research conclusion on this area may also be limited by estimate collation method.

The figures were averaged across people who patronized MFIs and those who didnt. In the short

term, if the figures recorded by those who took loans were considerably low, aggregating these

values over other people may only lead to an insignificant value.

Research Considerations

In spite of criticisms and good empirical research in explaining the impact of MFIs in alleviating

poverty, each research has its shortcomings in the approach used. Banerjee et al (2009), relies on

a small sample, which is the problem of most empirical work. Kaboski and Townsend (2005)

consider randomization on a larger scale with varying results that beyond the scope of this project.

Most empirical research helps to evaluate the results of instantaneous benefits from MFIs on the

lifestyle of borrowers. However, majority omits the effect of MFI study in the long run and on a large

scale of observation. MFI is an investment; it is hard to measure the effect of this investment in the

poorest society over 1-3 years (scale of most research). To assess the impact of MFIs, better

research on larger scale and longer periods should be done.


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Overall, researches provide evidence of the impact of MFIs in the local economy no matter how

small. To the poorest of the world, where credit and finance for business is practically unavailable,

without the presence of MFI many will live in a poverty trap eternally. MFIs may be argued then as a

starting point for poverty alleviation and not a Get-Rich-Quick Scheme. Where MFIs support

poverty alleviate, the question then is the longevity of the impact: will it be short-lived or sustainable

in these communities.

As explained by M.Godquin (2004) microfinance programs are now a key element of poverty

alleviation strategies. The financial innovations of their lending methodologies such as the use of

group lending, nonfinancial services and dynamic incentives have indeed raised the interest of

policy makers and researchers as means to alleviate poverty in a self-sustainable way.

P.R.Sharma (2004) explained that in Nepal, the poverty reduction rate is slower. If the proper model

is used in the region, poor peoples life standard could be raised very fast. In Nepal, the experience

shows that MFIs managed by private sector are better performed than the government owned MFIs.

Hence Nepal shows evidence of the impact of MFIs.

However, P.R.Sharma (2004) also explained that microcredit may not always be the answer,

explaining that micro credit is not suitable for everyone or every situation. The destitute and hungry

that have no income or means of repayment need other forms of support before they can make use

of loans. In many cases, small grants, infrastructure improvements, training programs, and other

nonfinancial services may be more appropriate tools for poverty alleviation.

Conclusion

Critical analysis has been done on the impact of MFIs in achieving the primary goal of poverty

alleviation. Evidence shows that in the short-run, it allows households to borrow, invest and improve

on living standards. However, there are questions on its accessibility and lending style, which may

live some of the poorest people in a poverty trap.

MFIs works in providing credit in communities where no credit or support is available. With the

growth of MFIs across developing countries, issues remain on how take microfinance further.

To an extent, in the long run MFIs may work better than hangouts or free aid to the poor and

vulnerable people, however research provides us with little evidence on the impact of microfinance.

Research on long run effects may provide more evidence and spillovers of economic factors maybe

the degree to which we will be able to measure and appreciate the impact of MFI on health and

education. The real effects may take time to be observed in the long run, regardless MFIs and

nonfinancial services could also be combined in order to help attain better poverty alleviation in the

long run.


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References

Banerjee, Abhijit, Esther Duflo, Rachel Glennerster and Cynthia Kinnan (2009). The Miracle

of Microfinance? Evidence from a Randomized Evaluation. Mimeo MIT.

Kassim, Salina and Rahman, Md Mahfuzur (2008) Handling Default Risks in Microfinance:The Case of Bangladesh. MRPA Paper

Microcredit Summit Campaign (2009). About Us. Accessed 15/03/2011

(http://www.microcreditsummit.org/about/what_is_microcredit/)

Consultative Group to Assist the Poor (2011). About Us. Accessed 16/03/2011

(http://www.cgap.org)

Consultative Group to Assist the Poor Key Principles of Microfinance Building Systems of

Homes. Accessed 16/03/11. (http://www.cgap.org/gm/document-

1.9.2747/KeyPrincMicrofinance_CG_eng.pdf )

Opportunity International (2010). What is Microfinance. Accessed 16/03/2011.

http://www.opportunity.org/what-is-microfinance/

Morduch, Jonathan (2010) Borrowing to Save, Journal of Globalization and Development:

Vol.1: Iss. 2, Article 8.

Marie Godquin (2004). Microfinance Repayment Performance in Bangladesh: How to

Improve the Allocation of Loans by MFIs. World Development. Vol. 32, No. 11, pp. 1909-

1926.

Puspa Raj Sharma (2004). Microfinance: A Powerful Tool for Social Transformation, Its

Challenges, and Principles. The Journal of Nepalese Business Studies. Vol. I No. 1.

Shahidur R.Khandker (2005). Microfinance and Poverty: Evidence Using Panel Data from

Bangladesh. World Bank Econ Rev 19 (2): 263-286

Shahidur R. Khandker, Baqui Khalily, Zahed Khan. (1995) Grameen Bank: performance and

sustainability. World Bank, Washington D.C.

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Micro Finance Institutions in Pratice