Admas University

The Role of Microfinance in Employment Creation

A thesis by Kadar Muse Ahmed

Date9/1/2012

The Role of Microfinance in Employment Creation

Chapter one

1. Introductions

1.1 Background

It has been estimated that there are 500 million economically active poor people in the world

operating microenterprises and small businesses women’s world banking 1995. Most of them do

not have access to adequate financial services.

To meet this substantial demand for financial services by low- income micro entrepreneurs,

microfinance practitioners and donors alike must adopt a long –term perspective. This research

is to bring together in a single source guiding principles and tools that will promote sustainable

microfinance and create viable institutions.

The goal of this research is to provide a comprehensive source for the design, implementation,

evaluation, and management of microfinance activities. Microfinance takes a global perspective,

drawing on lessons learned from the experiences of microfinance practitioners, donors, and other

throughout the world.

It offers readers relevant information that will help them to make informed and effective

decisions suited to their specific environment and objectives. Microfinance arose in the 1980s

and a response to doubts and research findings about state delivery of subsidized credit to poor

farmers.

In the 1970s government agencies were the predominant methods of providing productive credit

to those with no previous access to credit facilities –people who had been forced to pay interest

rate or were subject to rent seeking behavior.

Governments and international donors assumed that the poor required cheap credit and saw this

as a way of promoting agricultural production by small landholders.

In addition to providing subsidized agricultural credit, donors set up credit unions inspired by

the Raiffeisen model developed in Germany in 1864.

The focus of these cooperative financial institutions was mostly on savings mobilization in rural

areas in an attempt to “teach poor farmers how to save”. Beginning in the mid -1980s the

subsidized, targeted credit model supported by many donors was the subject of steady criticism,

because most programs accumulated large loan losses and required frequent recapitalizations to

continue operating.

It becomes more and more evident that market-based solutions were required. This led to a new

approach that considered microfinance as an integral part of the overall financial system.

Emphasis shifted from the rapid disbursement of subsidized loans to target populations toward

the building up of local, sustainable institutions to serve the poor. At the same time, local NGOs

began to look for a more long-term approach than the unsustainable income generation

approaches to community development.

In Asia DR. Mohammed Yunus of Bangladesh led the way with a pilot group-lending scheme

for landless people.

This later became the Grameen bank, which now serves more than 2.4 million clients (94

percent of them women) and is a model for many countries. In Latin America ACCION

international supported the development of solidarity group lending to urban vendors, and

Fundacion Carvajal developed a successful credit and training system for individual micro

entrepreneurs. Changes were also occurring in the formal financial sector.

Bank Rakyat Indonesia, a state- owned, rural bank, moved away from providing subsidized

credit and took an institutional approach that operated on market principles.

In particular, Bank Rakyat Indonesia developed a transparent set of incentives for its borrowers

(small farmers) and staff, rewarding on time loan repayment and relying on voluntary savings

mobilizations as a source of funds. Since 1980s, the field of microfinance has grown

substantially.

Donors actively support and encourage microfinance activities, focusing on microfinance that is

committed to achieving substantial outreach and financial sustainability.

Today the focus is on providing financial services only, whereas the 1970s and much of the

1980s were characterized by an integrated package of credit and training which required

subsidies.

Most of recently, microfinance NGOs (including PRODEM’ Banc sol in Bolivia, K-REP in

Kenya, and ADEMI’ BANCO ADEMI in the Dominican republic) have begun transforming into

formal financial institutions that recognize the need to provide savings services to their clients

and to access market funding source, rather than rely on donor funds.

This recognition of the need to achieve financial sustainability has led to the current “financial

systems” approach to microfinance. This approach is characterized by the following beliefs:

ÿ Subsidized credit undermines development.

ÿ Poor people can pay interest rates high enough to cover transaction costs and the

consequences of the imperfect information markets in which lenders operate.

ÿ The goal of sustainability (cost recovery and eventually profit) is the key not only to

institutional permanence in lending, but also to making the lending institution more

focused and efficient.

ÿ Because loan size to poor people is small, microfinance must achieve sufficient scale if

they are to become sustainable.

ÿ Measurable enterprise growth, as well as impacts on poverty, cannot demonstrate easily

or accurately outreach and repayment rates can be proxies for impact. One of them main

assumptions in the above view is that many poor people actively want productive credit

and that they can absorb and use it.

But as the field of microfinance has evolved, research has increasingly found that in many

situations poor people want secure savings facilities and consumption loans just as much as

productive credit and in some cases instead of productive credit.

Microfinance is beginning to respond to these demands by providing voluntary saving services

and other types of loans.

ÿ Sources of funds to finance loan portfolios differed by type of institution. NGOs relied

heavily on donor funding or concessional funds for the majority of their lending. Banks,

savings banks, and credit unions funded their loan portfolios with client and member

deposits and commercial loans.

ÿ NGOs offered the smallest loan sizes and relatively more social services than banks,

saving banks, or credit unions.

ÿ Credit unions and banks are leaders in serving large numbers of clients with small

deposit accounts. They study also found that basic accounting capacities and reporting

varied widely among institutions, in many cases revealing an inability to report plausible

cost and highlights the need to place greater emphasis on financial monitoring and

reporting using standardized practices a primary purpose of this research.

1.2 Statement of the problem

Microfinance is considered as a tool for socio-economic development, and can be clearly

distinguished from charity. Families who are destitute, or so poor they are unlikely to be able to

generate the cash flow required to repay a loan, should be recipients of charity.

Microfinance experts generally agree that women should be the primary focus of service

delivery. Evidence shows that they are less likely to default on their loans than men are more.

People cannot understand very well in important in microfinance.

1.3 Purpose of the study

Purpose microfinance delivers quality financial services how create poor people in opportunity.

These services include micro-saving, micro-loans, micro -insurance, and other remittances.

Micro-loans are given for a variety of purposes, frequently micro-enterprise development. The

diversity of products and services offered reflects the financial needs of individuals, households,

and enterprises can change significantly over time, especially for those who live in poverty.

Because of these varied needs, and industry focus on the poor. Purpose microfinance use non-

traditional methods such as group lending or other forms of collateral not employed by the

formal financial sector.

Our value of financial services to poor families helps them to engage in productive activities or

growing their business. Purpose microfinance we give some of the poorest women give some of

amount, to encourage how create new product in small micro finance.

1.4 Objectives of the research

1.4.1 General objective

Microfinance has evolved as an economic development approach intended to benefit low-

income women and men. In addition to financial intermediation many microfinance provides

social intermediation services such as group formation, development of self-confidence, and

training in financial literacy and management capabilities among members of group.

1.4.2 Specific objective

The specific objectives are:

ÿ The promise of reaching the poor: microfinance activities can support income generation

for enterprises operated by low-income households

ÿ The promise of financial sustainability: microfinance activities can help to build

financially self-sufficient, subsidy-free, often locally managed institution.

ÿ To reduce poverty

ÿ Participation in women microfinance

1.5 Scope

The scope of the research is the role in microfinance in employment creation. This research will

apply to Hargeisa city, and especially it focuses Kaaba Microfinance Institution, which related

that Poor people borrow from informal money lenders and save with informal collectors. They

receive loans and grants from charities.

They buy insurance from state-owned companies. . They receive funds transfers through formal

or informal remittance networks. It is not easy to distinguish microfinance from similar

activities.

1.6 Significance of the study

This research is benefiting our society specially the poor people to get it in opportunity.

Microfinance has successfully enabled extremely impoverished people, especially women, to

engage in self-employment projects.

These people were previously considered un bankable, as they typically do not meet even

minimal qualifications to gain access to traditional credit, such as steady employment or a

verifiable credit history. Microfinance allows them to generate income and to begin to build

wealth and ultimately exit poverty.

1.7 Limitations of the study

There are some of limitations in the microfinance. Firstly, there are little institutions in

Somaliland to talk about microfinance.

The data collections from respondents were challenged during the primary resource

Secondly it was a problem of tool when I was preparing and writing thesis book I had not enough

computer.

Thirdly, I met director for ministry of finance I have not found any report about microfinance.

Chapter two

2. Literature review

2.1 Definition of microfinance:

Microfinance is the provision of financial services such as loans, savings, insurance, and

training to people living in poverty.

“Microfinance” is often defined as financial services for poor and low-income clients offered by

different types of service providers. In practice, the term is often used more narrowly to refer to

loans and other services from providers that identify themselves as “microfinance institutions”

(MFIs). These institutions commonly tend to use new methods developed over the last 30 years

to deliver very small loans to unsalaried borrowers, taking little or no collateral. These methods

include group lending and liability, pre-loan savings requirements, gradually increasing loan

sizes, and an implicit guarantee of ready access to future loans if present loans are repaid fully

and promptly.

More broadly, microfinance refers to a movement that predict a world in which low-income

households have permanent access to a range of high quality and affordable financial services

offered by a range of retail providers to finance income-producing activities, build assets,

stabilize consumption, and protect against risks. These services include savings, credit,

insurance, remittances, and payments, and others.

2.2 Somaliland microfinance

Somaliland became independent in 1991. Since then, it has managed to restore many aspects of

normal society and develop different aspects of socio-economic activities. However it has lost

many issues like welfare of community, creating employment opportunity, decreasing financial

problems, eradicating poverty etc all these results the establishment of microfinance institutions.

Somaliland has a traditional system which is ROSCAs (rotating savings and credit associations)

called in Somali language (Hagbad) has existed for centuries in Somaliland, mainly among

women. In English-speaking countries they are known as merry-go-rounds; in French speaking

countries they are tontines.

A group of women join together to save small amounts each month- these sums are pooled and

the money handed over to one group member. She then has a sum slightly larger than normal and

can make one purchase that for her is large.

The next month another group member gets the funds and so on round the group. When

everyone has received a payment the group may start the process again, or change its members,

or disband. People who have been in such a group have already learnt the basics of money

transactions and obligations.

2.2.1 DOH AND STAGES OF DOH LOAN PROVISION

Doses of Hope (DoH) is an NGO that works in Somaliland. It was started by three refugees in

the Netherlands. It now has two main activities, micro credit and a second section that assists

disabled children and adults. Many disabilities are the result of the Civil War.

The first stage of DoH income-generation activities involved making individual loans. The

second stage was to loan to hagbad-type groups. Each group decided itself on its maximum

membership, mostly between thirty to fifty women. Then it decided on the members who will

receive the first loans, five to ten people. Each received a loan. Repayment was in equal monthly

installments. The group met monthly for repayments and other business.

As the first loans were repaid, the money was paid out immediately to one or more other

members, depending on the total amount collected. Once every member has received and repaid

their first loan, the whole cycle could start again, with second or more loans to its members.

The third stage was to loan to groups too poor to save even the small amounts involved in the

traditional hagbad.

With the current stage of activities, over 4,000 people are now being helped, one-third of them

women. When an individual applies for a loan s/he has to produce a business plan with the help

of one of the Loan Officers. Borrowers have to organize themselves into groups of about seven,

the group members being responsible for the repayments of any one of them. Each individual has

also to find an elder to stand as guarantor.

2.2.2 Kaaba microfinance institution

Kaaba Micro finance Institution’s (K-MFI) is a financial service provider that aims to strengthen

the economic base of the low-income self-employed in Somaliland through loans and savings

services with special emphasis on low-income women. The institution offers different kinds of

help and combines cost-efficient methodologies with a very high level of customer service.

K-MFI has been operating under Doses of Hope Foundation (DOH), a non-governmental

development foundation operating in Somaliland since 1998. Started in 1999 the first

micro finance project began with 150 women beneficiaries; from 1999 to 2007 the micro finance

program has gone through profound transformation and has scaled-up financial service delivery

and improved its financial outreach.

In partnership with Oxfam Novib, DOH has in 2008 begun the transformation of the micro

finance program into an independent micro finance institution now known as Kaaba Micro

finance institution (K-MFI). This transformation process started with a financial support of

EUR 150,000 from Oxfam Novib and culminated in the legal existence of K-MFI that was

formerly registered in February 2009. K-MFI’s main goal is to provide financial services to the

low-income and poor entrepreneurs (particularly women) in Somaliland to become self reliant

and serve as agents of change in their respective communities.

Building on the success realized in the start-up phase (2008 & 2009), the current phase

(intermediate level, 2010-2012) also financed by Oxfam Novib will focus on both geographic

and number of clients expansion from 1559 in 2009 to 5000 in 2012 through set up of 2 branches

in rural and urban locations of Hargeisa, & Gabiely districts

2.2.4 REPAYMENT

Effective measures have to be in place to ensure repayment. If it becomes known that defaulting

or failure to pay is possible, it could become common. The measures are as follows:

¸ Loans are only made for business purposes, with an approved business plan.

¸ The borrower has to find an Elder as guarantor.

¸ Administrative costs are deducted before money is handed over.

¸ Repayment is made in five segments.

¸ A reluctant repair is firstly the responsibility of the group of seven who borrow with

responsibility for each other.

¸ If this fails, the Loan Officer will chase up the non-payer, look at whether the business is

failing and see how it can be got back on track.

¸ If this also fails, the guarantor ensures that Doses of Hope will be repayed but the process

takes time and trouble. A few defaulters, perhaps 5-10%, will still need to be taken to

court.

¸ It is said that Somali women repay loans but Somali men do not. The DoH records show

100% of women and most men repay without trouble.

¸ The repayment figures noted by the external auditors are now between 87% and 92.4%

2.3 Women in microfinance

WMI's goal is to help women build assets so that they can stabilize their income, raise their

standard of living and reorient themselves and their families. WMI's small loans bring big

changes to impoverished women, who use the money to build small businesses.

Example of women beneficiary In Somaliland:

Amina Saleh is a woman living in Hargeisa, the capital. In 2000 she approached DoH as an

individual. She was asked to form a group and she found five other would-be borrowers. Her

idea was to start baking bread in a pit oven. She worked out a business plan and received $200

minus $20 for administrative costs.

She used the money for ingredients, tools and also for the renting of space in a neighbor’s lock-

up where she could store things. She baked bread each morning before it was light and then took

it to the market to sell. Her profits have allowed her to repay the loan, build a proper oven, and

provide work for her husband and two paid employees. She has built two more rooms on to her

one-room hut. They were needed; she has five children. And now the children can go to school.

2.3.1 Empowering women by microfinance!?

Against the background of an increasing feminization of poverty in the developing world,

microfinance programs represent important means for promoting women’s empowerment.

However, most of these programs are only focused on individual and purely economic

empowerment but do not involve full and equal participation of women in all spheres of society.

In order to improve the effectiveness of microfinance programs for women, it is necessary to

integrate a societal and political dimension which enables women to participate in decision-

making processes above and beyond the family context.

A report by Alexandra Dobra, published in the “International Politics and Society” journal of the

Friedrich Ebert Foundation, depicts important limits of microfinance programs for women:

According to the Microcredit Summit 2005, women represent 70 percent of individuals living on

less than 1 us dollar a day. Not only do women represent the major part of the poorest

individuals, but in addition they are also the most vulnerable.

Microfinance programs have proven to be important instruments to fight against female poverty

and vulnerability in developing countries. Among the 81.9 million poor clients served by

microfinance programs in 2005, 84.2 percent were women (World Bank 2005). Microfinance, by

targeting women, allows not only improvements in gender equality but also effective decreases

in poverty through the positive effect of gender equality on development.

Using microfinance programs to give women access to financial services is a means of

mobilizing their productive capacities for the benefit of economic development. Through access

to financial resources, microfinance not only gives women access to self-employment, but also

contributes to the amelioration of family life and influences the social situation of women by

promoting self-confidence and the capacity to play an active role in society. Moreover,

extrapolating from household expenditure by working women it appears that women are more

inclined to be altruistic and spend most of their money on their families. In this way, the

wellbeing of the whole family and society is improved.

Although the social dimension of microfinance enables the emergence of female empowerment,

the latter is too underdeveloped. In most instances, microfinance programs only enhance

personal empowerment but do not involve full and equal participation of women in all spheres of

society, including decision-making and access to power. In most developing countries, women

are for example still largely under-presented in politics.

2.3.2 Measuring the Impact of Microfinance on Women's Empowerment

Given the complexity of defining women’s empowerment it is not surprising that only a few

empirical studies have tried to examine the impact of microfinance on women’s empowerment.

For the most part, empirical research on microfinance’s effect on women’s empowerment has

been conceptually ungrounded and tends to estimate an over-extended definition of

empowerment or a truncated aspect of it. A number of these studies also suffer from

methodological bias and flaws. In fact, only a few studies have successfully investigated this

impact in a rigorous manner.

The interpretation of women’s empowerment and its measurement varies across studies. Most

researchers construct an index/indicator of women empowerment. However, measuring women

empowerment by constructing indices is an inappropriate technique as it allows the use of

arbitrary weights.

Most researchers, for instance, will agree that impact of a women’s decision to buy cooking oil

for the family is different in nature from her participation in a decision to buy a piece of land.

Both these decisions have different implications and magnitude of impact on her empowerment.

As such giving equal weight to both these decisions does not make sense. At the same time,

suggesting an arbitrary weight for these decisions is also inappropriate, as it is not for the

researchers to decide the factor by which the latter decision contributes more to women

empowerment.

Other studies use Item Response Theory, where the element of analysis is the whole pattern of a

set of binary indicators that proxy for woman’s autonomy, decision-making power, and

participation in household and societal decision making. These studies have found that credit

programs allow women to take a greater role in household decision making; to have greater

access to financial and economic resources; to have greater access to financial and economic

resources; to have greater social networks and more bargaining power vis-à-vis their husbands;

and to have greater freedom of mobility.

2.4 Financial Sector Regulation and administration

One of the most important issues in microfinance today is the regulation and supervision of

MFIs. As mentioned, most informal and semiformal organizations providing financial services to

microenterprises do not fall under the government regulations that are applied to banks and other

formal financial institutions.

Many nonbank MFIs, especially NGOs, operate on the fringes of existing regulations,

especially with regard to deposit mobilization. In some instances they do so with the knowledge

of the authorities, who, for political reasons or simply for lack of time and resources, do not

interfere.

In other instances these nonbank MFIs simply avoid dealing with the issues and proceed with

deposit mobilization by calling it something else. All parties involved in microfinance in a

particular country need to understand the dynamic of these legally ambiguous operations.

One important danger is that as more bank and nonbank MFIs begin operating, authorities who

have been disposed to liberal interpretations of the regulations will be forced to invoke a much

stricter construction of the laws, thus tipping the balance unfavorably from the point of view of

those engaged in microfinance.

The following discussion focuses on issues that must be considered when regulating and

supervising MFIs. The information is most useful for governments that are considering

regulating the microfinance sector. It is also helpful for both practitioners and donors to

understand what is involved if and when an MFI becomes regulated so that they know how the

MFI will be affected. Furthermore, if donors and practitioners are aware of the issues involved,

they can potentially influence government decisions regarding regulation of the sector and

propose self-regulatory measures.

Financial regulation refers to the body of principles, rules, standards, and compliance

procedures that apply to financial institutions. Financial supervision involves the examination

and monitoring of organizations for compliance with financial regulation. Prudential regulation

and supervision are designed to (Chavez and Gonzalez-Vega 1995): Avoid a banking crisis and

maintain the integrity of the payments system Protect depositors

Encourage financial sector competition and efficiency.

To create an environment that is conducive to financial intermediation, governments and

policymakers must ensure that financial regulation does not result in financial repression in

regulations that distort financial markets and reduce the efficiency of financial institutions.

Examples of financial repression are imposed interest rate ceilings, subsidized credit, and tax

structures that discourage investment in microfinance.

Governments must also ensure that supervisory bodies have the authority and the capacity to

implement the regulatory standards (Chavez and Gonzalez-Vega 1994).

Despite some success stories, MFIs probably reach less than 5 percent of the potential clients in

the world today.

Serving this market will require access to funding far beyond what donors and governments can

provide. Thus many MFIs want to expand their outreach by raising funds from commercial

sources, including deposits. Most MFIs are significantly different from commercial banks in

institutional structure. Furthermore, managing a microloan portfolio differs in important ways

from managing a conventional bank portfolio.

MFIs and microloan portfolios cannot be safely funded with commercial sources, especially

public deposits, unless appropriate regulation and supervision regimes are developed. Even MFIs

that do not mobilize deposits may benefit from entry rules that ensure the adoption of accepted

good practices, as well as adequate recordkeeping and reporting.

2.4.1 Microfinance Banks

Microfinance banks come in many different varieties and structures. In some cases, these banks

are nonprofit organizations that have the goal of helping the poor. In other cases, large banks

that do business in normal markets branch out to create a banking solution for the poor.

In some countries, government organizations are set up to help facilitate microfinance lending

solutions for the needy. Regardless of the type of entity, the basic idea behind the lending is the

same.

Purpose

Many microfinance banks take this mission of providing credit to the poor very seriously. In

fact, according to Grameen Bank, credit is promoted as a basic human right that everyone should

have access to.

By providing credit to these individuals, it can help them get out of poverty and create

something better for themselves. If these loans are used correctly, they could potentially help

these poor people to create thriving businesses that help provide all of their needs in the long

run.

2.4.2The First Micro-Finance Bank

Grameen Bank was the first micro-finance bank, and has now been in existence for over 30

years. It started as a project formed in 1976 by Professor Muhammad Yunus, an Economics

Professor at Chittagong University in Bangladesh.

He wanted to help village women in Bangladesh raise themselves from poverty, lending them

money to buy cell phones, then encouraging them to charge neighbors who wanted to use the

phones. His project started based on the notion that abilities of the poor are underestimated, and

he viewed them as people who learned thrift, persistence and creativity due to living on $1 to $2

per day. What they were lacking was access to funding to start and grow businesses.

Professor Yunus received the Nobel Peace Prize in 2006 for his humanitarian work in founding

and running Grameen Bank. The bank has been profitable since 1983, but does not mark up its

interest rates to what the market will bear, which businesses typically do to maximize profits.

Professor Yunus feels the only important thing to accomplish when helping the poor is to

recover costs.

2.4.3 Success or failure

Today the micro-finance field has become full with continued rapid growth. What started out as

nonprofit work has been infiltrated with commercial investors and for-profit entities. More than

1,200 micro-finance institutions have appeared in modern years, and the industry is still growing

at 25 percent per year with approximately 64 million individuals borrowing money.

Future forecast

Success and progress can be very slow, sometimes taking more than a generation. Micro-finance

raises standards of living slowly but surely, and The Grameen Foundation, a separate nonprofit

entity from Grameen Bank, has performed several studies that support this assertion.

The ultimate outcome of micro-financing, which may take a significant amount of time, is to

change the vicious low income, low savings and low investment cycle of the poor into one that

results in the ability to create business income with a loan, make enough profit to invest more in

the business, continue growing revenue and the business, and finally have the ability to start

saving.

2.5 The principles of microfinance

Principle one:

Poor households and communities need access to a variety of financial services, not just

loan.

Like other people, the poor need access to a wide range of financial services that

are convenient, flexible, and reasonably priced. Depending on their circumstances,

poor people generally need not only credit, but also access to savings, cash transfers, and

insurance.

Principle two:

Interest rate ceilings can damage poor people’s access to financial services

The per unit costs involved in making many small loans are significantly higher than those

associated with fewer, larger loans. Likewise, operating in high inflationary environments with

weak financial markets, and engaging in uncollateralized lending to people living in remote

areas, is considerably more expensive than collateralized lending to urban residents in a

developed and stable economy.

It is therefore not appropriate to compare interest rates and fees across countries, geographical

locations, and clients. Unless microfinance providers can charge interest rates that are above

average bank loan rates, they invariably cannot cover their costs, and their growth and

sustainability will be limited by the scarce and uncertain supply of subsidized funding.

When governments regulate interest rates, they usually set them at levels too low to permit

sustainable microfinance. At the same time, microfinance providers must avoid setting a

sustainable interest rate based on an inefficient operation as this results in operational

inefficiencies and related costs being passed on to poor clients and may reduce the pressure on

the provider to improve its performance.

In order to avoid this situation, clear pricing policies and mechanisms should be in place and

shared with stakeholders and funders to ensure that all parties can together monitor interest rates

to ensure their appropriateness.

Principle three:

Credit is not always appropriate

Credit is not appropriate for everyone or every situation. The destitute and hungry

who have no income or means of repayment typically need other forms of support

before they can make effective use of loans. In many cases, small grants, community

infrastructure improvements, health and education services, employment and training programs

and other non-financial services may be more appropriate tools for poverty alleviation.

Wherever possible, poor clients should be encouraged and supported to build a small savings

base and develop basic money management skills prior to taking on the risks associated with

credit.

Principle four:

Donor subsidies should complement, not compete with private sector capital

Donors should use appropriate grant, loan, and equity instruments on a temporary basis to build

the institutional capacity of financial providers, develop supporting infrastructure (like rating

agencies, credit bureaus, audit capacity, etc.), and support experimental services and products.

In some cases, longer-term donor subsidies may be required to reach sparsely populated and

otherwise difficult-to reach populations. To be effective, donor funding must seek to integrate

financial services for the poor into local financial markets; apply specialist expertise to the

design and implementation of projects, require that financial institutions and other partners meet

minimum performance standards as a condition for continued support; and plan for exit from the

outset.

Principle five:

The importance of financial and outreach transparency

Because microfinance has a social agenda and involves a wide range of stakeholders, it is

important that accurate and comparable information be available to monitor and assess the social

and financial performance of programs.

This information is required by bank supervisors, regulators, donors, investors and clients so that

they can adequately assess the risks and returns associated with various providers and services.

The microfinance industry is vulnerable to political interference because of its need to charge

higher than usual levels of interest to poor clients.

Transparent financial and outreach reporting can help to mitigate concerns related to unfair

pricing of products and thereby promote the sustainability of the microfinance industry as a

whole.

Principle six:

The role of governments is as an enabler, not as a direct provider of financial services.

Governments play an important role in setting a supportive policy environment that

Stimulate the development of financial services while protecting poor people’s savings.

Governments can best support microfinance by promoting macroeconomic stability, avoiding

interest-rate caps and refraining from distorting the market with unsustainable, subsidized loan

programs.

Governments can also support financial services for the poor by improving the business

environment for micro-entrepreneurs, clamping down on corruption, and improving access to

markets and infrastructure.

Government’s are not well placed to provide financial services directly to clients, and tend to

distort the market and reduce the quality and level of service provision when they do so. In

certain situations, government funding for sound, independent microfinance institutions may be

warranted when other funding sources are not available.

Principle seven:

Microfinance means building financial systems that serve the poor.

In many countries, microfinance continues to be seen as a marginal sector and primarily a

development concern for donors, governments, and socially responsible investors. In order to

achieve its full potential of reaching a large number of poor people, microfinance needs to

become an integral part of the financial sector. This requires the involvement of conventional

financial service providers, regulators and related industry bodies.

2.7.0 Islamic in microfinance

2.7.1 Mudarabah

Mudarabah has the potential to be adapted as Islamic microfinance scheme. Mudarabah is where

the capital provider or microfinance institution (rabbul mal) and the small entrepreneur

(mudarib) become a partner. The profits from the project are shared between capital provider and

entrepreneur, but the financial loss will be borne entirely by the capital provider.

This is due to the premise that a mudarib invests the mudarabah capital on a trust basis; hence it

is not liable for losses except in cases of misconduct. Negligence and breach of the terms of

mudarabah contract, the mudarib becomes liable for the amount of capital.

Mudarabah structure could be based on a simple or bilateral arrangement where Islamic bank

provides capital and the micro-entrepreneur acts as an entrepreneur.

Mudarabah structure may also be based on two-tier structure or re-mudarabah where 3

parties i.e. capital provider (public, government, zakat, waqf etc.), intermediate mudarib (Islamic

Bank) and final mudarib (micro entrepreneur).

The profit-sharing ratio on mudarabah is pre-determined only as a percentage of the business

profit and not a lump sum payment. The profit allocation ratio must be clearly stated and must be

on the basis of an agreed percentage. Profit can only be claimed when the mudarabah operations

make a profit. Any losses must be compensated by profits of future operations.

After full settlement has been made, the business entity will be owned by the entrepreneur. The

entrepreneur will exercise full control over the business without interference from the Islamic

bank but of course with monitoring. On the practical side, there is a problem to determine the

actual total profit to be shared because micro entrepreneurs normally do not have proper

accounts or financial statement [Dhumale and Sapcanin 1999].

Meanwhile, muzara’ah is a form of mudarabah contract in farming where Islamic bank can

provide land or monetary capital for farming product in return for a share of the harvest

according to the agreed profit sharing ratio. In the context of microfinance, the capital provider

may need huge capital and expertise to manage such initiative and may need to manage higher

risk because the Islamic bank need to involve directly in the farming sector through provision of

asset such as land.

In the case of mudarabah, the Islamic bank may face capital impairment risk as loss making

operations of micro entrepreneurs expose the Islamic bank to the risk of capital erosion.

In addition, since in mudarabah the Islamic bank should not request collateral may expose

Islamic bank to credit risk on these transactions. As part of risk mitigation, even though the

entrepreneur exercises full control, Islamic bank can still undertake supervision [Iqbal and

Mirakhor 1987].

2.7.2 Musharakah

Musharakah can also be developed as a micro finance scheme where Islamic bank will enter

into a partnership with micro entrepreneurs. If there is profit, it will be shared based on pre-

agreed ratio, and if there is loss, it will then be shared according to capital contribution ratio.

The most suitable technique of musharakah for microfinance could be the concept diminishing

partnership or musharakah mutanaqisah.

Musaharakah Mutanaqisah

A: (Islamic Bank 80%) B: (Micro Entrepreneur 20%)

Another form of musharakah is musaqat. Musaqat is a profit and loss sharing partnership

contract for orchards. In this case, the harvest will be shared among all the equity partners

(including entrepreneur as a partner) according to the capital contributions. All the musharakah

principles will be applicable for this form of musharakah.

This scheme, however, could be of high risk, since it needs the capital and expertise to directly

involve in the business especially in managing the orchards. Musharakah capital may also be

subjected to capital impairment risk, where the capital may not be recovered, as it ranks lower

than debt instruments upon liquidation [Haron and Hock 2007].

The normal risk mitigation techniques that can be adopted by Islamic banks are also applicable

in the case of microfinance i.e. through a third-party guarantee. This guarantee can be obtained

and structured for the loss of capital of some or all partners through the active role of the so

called Credit Guarantee Corporation (CGC) as practiced in the case of SME financing in

Malaysia.

2.7.3 Murabahah

Using murabahah as a mode of microfinance requires Islamic bank to acquire and purchase

asset or business equipment then sells the asset to entrepreneur at mark-up. Repayments of the

selling price will be paid on installment basis. The Islamic bank will become the owner of the

asset until the full settlement. This scheme is the most appropriate scheme for purchasing

business equipment. This mode of financing has already been introduced in Yemen in 1997.

In 1999, there are more than 1000 active borrowers [Dhumale and Sapcanin 1999]. Borrowers

must form a group of 5 micro entrepreneurs where all members will act as guarantor if there is

default among their group members. The benefit of this mode of financing is continuous

monitoring, and entrepreneurs with a good reputation of repayment will be offered extra loan

found to be more practical and most suitable scheme for Islamic microfinance to be provided by

Islamic banks. This is due to the fact that the buy-resell model which allows repayments in equal

installment is easier to administer and monitor.

The above diagram indicates the application of the extended concept of murabahah i.e.

Murabahah to the Purchase Orderer. This is where a micro-entrepreneur enters into a sale and

purchase agreement, or memorandum of understanding to purchase a specific kind of goods or

equipments needed by the micro-entrepreneur with the Islamic bank.

The Islamic bank then sells the goods to the entrepreneur at cost plus mark-up, and entrepreneur

can pay back later in lumpsum or by installments (bai muajal). A number of shari’ah principles

must be met for the contract to be valid [Haron and Hock 2007].

Such as the goods must in existence at the time of sale; ownership of the goods must be with the

bank; the goods must have the commercial value; the goods are not be used for a “haram”

purpose; the goods must be specifically identified and known; the delivery of goods is certain

and not conditional upon certain other events; and, the selling price is fixed at cost plus mark up

Murabahah could be easily implemented for microfinance purposes and can be further

exemplified by the used of deferred payment sale (bai’ al-muajal). Murabahah, however, may

expose Islamic bank as in the case conventional lending to credit risk.

This, however, can be mitigated by requesting for an urboun, a third party financial guarantee, or

pledge of assets. In addition, Islamic bank can also institutes direct debit from the entrepreneur’s

account, centralizes blacklisting system, and minimum non-compounded penalty to deter

delinquent entrepreneurs. Murabahah to the Purchase Orderer also exposes Islamic banks to

delivery risk where goods are not delivered, goods not delivered on time, or goods delivered not

according to specification by the entrepreneur after payment is made by the Islamic bank. To

mitigate delivery risks, Islamic bank may request a performance guarantee from the seller to give

assurance on the delivery of goods.

2.7.4 Ijarah

Ijarah by definition is a long term contract of rental subject to specified conditions as

prescribed by the shari’ah. Unlike conventional finance lease, the lessor (Islamic bank) not only

owned the asset but takes the responsibility of monitoring the used of asset and discharges its

responsibility to maintain and repair the asset in case of mechanical default that are not due to

wear and tear.

Ijarah Muntahia Bitamleek is an elaborate concept of ijarah where the transfer of ownership

will take place at the end of the contract and pre-agreed between the lessor and the lessee. The

title of the asset will be transferred to the lessee either by way of gift, token price, pre-

determined price at the beginning of the contract or through gradual transfer of ownership.

Ijarah Muntahia Bitamleek is more suitable for micro finance scheme especially for micro

entrepreneurs who are in need of assets or equipments. Islamic bank will purchase the assets

required by the entrepreneurs and rent the assets to qualified entrepreneurs.

In this case, the entrepreneurs can just rent the asset over a period of time and pay the rentals at

regular intervals. The entrepreneur as a lessee will be responsible to safeguard the asset whereas

the lessor will monitor their usage.

For ijarah, the Islamic bank may be exposed to settlement risk where the entrepreneur as a lessee

is unable to service the rental as and when it falls due.

Similarly, the Islamic bank can request an urboun from the entrepreneur which can also be taken

as an advance payment of the lease rental. Alternatively, the Islamic bank as the owner of the

asset should has the right to repossess the asset.

2.7.5 Qardhul Hasan

Another simple concept that can be advanced for microfinance purposes is qardhul hasan or

simply means an interest free loan. Islamic bank can provide this scheme to the entrepreneurs

who are in need of small start-up capital and have no business experience. The Islamic bank then

will only be allowed to charge a service fee.

The term of repayment will be on installment basis for an agreed period. The scheme is also

relevant for micro entrepreneurs who are in need of immediate cash and has good potential to

make full settlement. Here, the Islamic bank will bear the credit risk and they need to choose the

right technique to ensure repayments will be received as agreed

Chapter three

3.0 Research Methodology

3.1 Methods of data collection

This research used both qualitative and quantitative data.

When I was preparing this research paper, the research methodologies used are included:

ÿ Primary data: questionnaire and interview distribution

ÿ Secondary data: text book documents, Internet

Primary data:

The primary data of this research paper were obtained from the questionnaires and interview

distributed to the role of microfinance in employment creation.

1. Interviews: - The study use questionnaires to collect information from the people who

have a good experience in financial institutions of the organizations treat to it.

2. Questionnaires: - The research adopted this tool for the planning and gathering

information by using simple random sampling design. The questionnaire is intended to

know the precise and reliable ideas about the balancing authority and responsibility in

improving organization performance in order to ensure the organization goals in

managerial means.

Secondary data:

The researcher traced before studies relevant to this subject matter to help present evaluation,

concepts and techniques. These data were from different sources includes textbooks and internet.

3.2. Limitations of the study

The following were the limitations of the study

ÿ Difficulty of data gathering: - another remarkable limitation existed when distribution

and collection was taken more extra time. The most obstacle that I met during

contributing the questionnaire and collecting data, were the decision makers of

organizations of and their senior subordinate staff could not been seen first.

ÿ This made it difficult to collect easily because every answerable person was busy and did

not try to respond as soon as you want. Due to lack of willingness to respond, some

invitees have lost the questionnaire papers.

ÿ There are some of limitations in the microfinance. Firstly, there are little institutions in

Somaliland to talk about microfinance.

ÿ The data collections from respondents were challenged during the primary resource

ÿ Secondly it was a problem of tool when I was preparing and writing thesis book I had not

enough computer.

ÿ Thirdly, I met director for ministry of finance I have not found any report about

microfinance.

Chapter Four

4. Data Analysis

4.1 Introduction

This chapter explains analysis of the collected information and it concerned the questionnaires

and interviews that the researcher collect from the respondents during the data collection and it

shows in tables and graphs which is pie chart, par chart, histogram and simple tables, the tables

will contain numbers as well as percentage of the alternative, and interpretation will be

evaluating the finding and comparing the results.

The questionnaires of this chapter are 15 questions and it mainly focuses on the role of

microfinance in employment creation there are 3 questions which have not directly related the

topic and the researcher didn’t illustrate as a table or graph because it does not give a more sense

about the topic and the analysis are as follows

1. Marital Status

90% of the respondents were single and 10% were married, this may not direct effect about the

response.

2. Age of the respondent

The respondents answered in a same age which is between 15-30

3. Level of Education

95% of the respondents were university level where as 5% of the respondents were secondary

level

Question 4.1: gender of the respondent

Table 1.1

Gender of the Respondent

Frequency Percent Valid

Percent

Cumulative

Percent

Male 15 75.0 75.0 75.0

Female 5 25.0 25.0 100.0

Total 20 100.0 100.0

Table4.1 and Chart4.1 shows that 25% of the respondents were female where as 75%of the

respondents were male; this shows that my questionnaires mostly were distributed male due to

the randomly selected method

Question4.2. Job of the respondent

Table 4.2

Job of the respondent

Frequenc

y

Percent Valid

Percent

Cumulative

Percent

Student 12 60.0 60.0 60.0

NGO 3 15.0 15.0 75.0

Microfinance instit. 2 10.0 10.0 85.0

Other job 3 15.0 15.0 100.0

Total 20 100.0 100.0

Table and Chart4.2 explains that 60% of the respondents were students which shows that mostly

and the majority of the respondents of this questionnaire were not getting working and hiring

employment while 15% were employees of NGO, 10% were working microfinance institutions

and 15% were doing other jobs

Question 4.3 Micro finance institutions have successful services

Table 4.3

Micro finance Institutions have successful services

Frequency Percent Valid

Percent

Cumulative

Percent

Agree 12 60.0 60.0 60.0

Disagree 8 40.0 40.0 100.0

Total 20 100.0 100.0

Table 4.3 and Chart4.3 shows the services and performance of micro finance institutions which

60% agreed that micro finance institutions has successful service while 40% Disagreed that

microfinance institutions performed in a successful services.

Question 4.4Microfinance has importance to the community

Table 4.4

Microfinance services has importance to the community

Frequency Percent Valid

Percent

Cumulative

Percent

Yes 16 80.0 80.0 80.0

No 4 20.0 20.0 100.0

Total 20 100.0 100.0

The above table and chart 4.4 illustrates that 80% of the respondents were answering Yes that

the microfinance institution services has importance to the community while 20% of the

respondents were answering No that micro finance has importance to the community this means

that majority were understanding the advantage of it, it also gives that microfinance services has

vital role to the community.

Question 4.5 Have you ever used in microfinance activities?

Table 4.5

Have you ever used in microfinance activities?

0

20

40

60

80

Yes No

80

20

Micro finance institutions has importance to the community

Percent

Frequency Percent Valid

Percent

Cumulative

Percent

Yes 9 45.0 45.0 45.0

No 11 55.0 55.0 100.0

Total 20 100.0 100.0

This above chart and table 4.5 explains that 45% of the respondents answering Yes that they

used the microfinance activities like borrowing money from microfinance institutions where as

55% of the respondents were answering No we never ever used the financial services. This

means that mostly of the people were not used this kind of microfinance activities.

Question 4.6 what did you have in your mind if you take a micro credit?

Table 4.6

What did you have in your mind, if you take a micro credit?

Frequency Percent Valid

Percent

Cumulative

Percent

Creating business 10 50.0 50.0 50.0

Continuing an existing

business7 35.0 35.0 85.0

Lending other people 1 5.0 5.0 90.0

Using buying goods for

luxury2 10.0 10.0 100.0

Total 20 100.0 100.0

As the table and chart above shows the respondents have their mind if they take a micro credit

that 50% will create business, while 35% continuing an existing business, where as 5% will

lending other people and the remaining 10% were answering they use buying goods for luxury.

Question 4.7 what does microfinance institutions contributed the people of Somaliland?

Table 4.7

The microfinance institutions contributed the people of Somaliland

Frequency Percent Valid

Percent

Cumulative

Percent

Employment

creation4 20.0 20.0 20.0

Source of income 8 40.0 40.0 60.0

Self dependence 2 10.0 10.0 70.0

All 6 30.0 30.0 100.0

Total 20 100.0 100.0

As the above table and chart indicates that 20% of the respondents says employment creation is

contributed the micro finance institutions while 40% responded we get as a source of income in

the microfinance institutions and only 10% were responded self dependence while the remaining

30% answered All, that the microfinance institutions were contributed the people in employment

creation, source of income and self dependence. This shows that the majority of the people

benefits as a source of income by the microfinance institutions.

Question4. 8 The relationship between micro finance and Islamic religion is;

Table 4.8

The relationship between microfinance and Islamic religion is

Frequency Percent Valid Percent Cumulative Percent

Strong relationship 18 90.0 90.0 90.0

Weak relationship 2 10.0 10.0 100.0

Total 20 100.0 100.0

Table 4.8 and chart 4.8 indicates that 18 respondents equivalent to 90% were answered there is

strong relationship between microfinance and Islamic religion and 2 respondents equivalent 10%

Respond weak relationship between microfinance and Islamic religion.

Question 4.9 did you have a job before borrowing money by the microfinance institutions?

Table 4.9

Did you have a job before borrowing money by microfinance institution?

Frequency Percent Valid Percent Cumulative

Percent

4 20.0 20.0 20.0

Yes 7 35.0 35.0 55.0

No 9 45.0 45.0 100.0

Total 20 100.0 100.0

Table 4.9 and chart above shows that 7 respondents equivalent 35% were answered Yes we have

a job before borrowing money by the microfinance, where as 9 respondents equivalent 45%

answered No we don’t have job, and 4 respondents equivalent 20% were not answered this

question as a whole as indicates the graph and table above..

Question 4.10 role of women in microfinance activities in Somaliland is;

Table 4.10

Role of women in microfinance activities in Somaliland is:

Frequency Percent Valid Percent Cumulative

Percent

High 8 40.0 40.0 40.0

Middle 7 35.0 35.0 75.0

Low 5 25.0 25.0 100.0

Total 20 100.0 100.0

As table and chart 4.10 indicated that 40% of the respondents says the role of in microfinance

activities in Somaliland is high, where as 35% of the respondents answered Middle and 25% of

the respondents answered Low the role of women is low, this explains that the majority of the

respondents agreed high and middle which means the role of women in microfinance activities

is more and effective.

Question 4.11 Women has more beneficial than men in microcredit activity

Table 4.11

Frequency Percent Valid Percent Cumulative Percent

Strongly agree 6 30.0 30.0 30.0

Agree 10 50.0 50.0 80.0

Disagree 3 15.0 15.0 95.0

Strongly

disagree1 5.0 5.0 100.0

Total 20 100.0 100.0

As the table and chart above demonstrates the comparison of men and women in the benefit of

microcredit activities, this shows that30 % of the respondents strongly agree that women has

beneficial than men in microcredit activity, where as 50% of the respondents agree that women

has more beneficial than men, where as 15% and 5% of the respondents disagree and disagree

respectively that women has more helpful and beneficial than men.

Question 4.12 Poor families and community are needed to

access financial services.

Table 4.12

Frequency Percent Valid Percent Cumulative

Percent

Yes 17 85.0 85.0 85.0

No 3 15.0 15.0 100.0

Total 20 100.0 100.0

The table 4.12 and chart 4.12 shows that 85% of the respondents says Yes poor families and

poor communities are needed to access financial services, where as 15% answered No poor

families are not needed the financial services, this indicates that majority of the respondents

answered the poor community are needed to access and take part the financial micro credit

services.

Chapter five

5.1 Conclusion

Microfinance is the provision of financial services such as loans, savings, insurance, and

training to people living in poverty. More broadly, microfinance refers to a movement that

predict a world in which low-income households have permanent access to a range of high

quality and affordable financial services offered by a range of retail providers to finance

income-producing activities, build assets, stabilize consumption, and protect against risks. These

services include savings, credit, insurance, remittances, and payments, and others.

Using microfinance programs to give women access to financial services is a means of

mobilizing their productive capacities for the benefit of economic development. Through access

to financial resources, microfinance not only gives women access to self-employment, but also

contributes to the amelioration of family life and influences the social situation of women by

promoting self-confidence and the capacity to play an active role in society.

Somaliland microfinance: Somaliland became independent in 1991. Since then, it has managed

to restore many aspects of normal society and develop different aspects of socio-economic

activities. However it has lost many issues like welfare of community, creating employment

opportunity, decreasing financial problems, eradicating poverty etc all these results the

establishment of microfinance institutions.

Somaliland has a traditional system which is ROSCAs (rotating savings and credit associations)

called in Somali language (Hagbad) has existed for centuries in Somaliland, mainly among

women. In English-speaking countries they are known as merry-go-rounds; in French speaking

countries they are tontines.

A group of women join together to save small amounts each month- these sums are pooled and

the money handed over to one group member. She then has a sum slightly larger than normal and

can make one purchase that for her is large.

The next month another group member gets the funds and so on round the group. When

everyone has received a payment the group may start the process again, or change its members,

or disband. People who have been in such a group have already learnt the basics of money

transactions and obligations.

Microfinance banks come in many different varieties and structures. In some cases, these banks

are nonprofit organizations that have the goal of helping the poor.

Grameen Bank was the first micro-finance bank, and has now been in existence for over 30

years. It started as a project formed in 1976 by Professor Muhammad Yunus, an Economics

Professor at Chittagong University in Bangladesh.

He wanted to help village women in Bangladesh raise themselves from poverty, lending them

money to buy cell phones, then encouraging them to charge neighbors who wanted to use the

phones. His project started based on the notion that abilities of the poor are underestimated, and

he viewed them as people who learned thrift, persistence and creativity due to living on $1 to $2

per day. What they were lacking was access to funding to start and grow businesses.

Professor Yunus received the Nobel Peace Prize in 2006 for his humanitarian work in founding

and running Grameen Bank. The bank has been profitable since 1983, but does not mark up its

interest rates to what the market will bear, which businesses typically do to maximize profits.

Professor Yunus feels the only important thing to accomplish when helping the poor is to

recover costs.

Purpose: Many microfinance banks take this mission of providing credit to the poor very

seriously. In fact, according to Grameen Bank, credit is promoted as a basic human right that

everyone should have access to.

By providing credit to these individuals, it can help them get out of poverty and create

something better for themselves. If these loans are used correctly, they could potentially help

these poor people to create thriving businesses that help provide all of their needs in the long

run.

5.2 Recommendation

I would like to recommend the following points which I hope will be more essential to how does

microfinance upgrade the role of microfinance in employment creation.

Therefore they can be:

ÿ The government of Somaliland should be establish to microfinance institution

ÿ The poor people must have know the advantage of microfinance

ÿ The government must make programs about microfinance in order people realize the

important of microfinance to small business.

ÿ The government must make roles and regulations in microfinance

ÿ The relationship between banks and microfinance activities should be strong relation

ÿ The government must planning how to create job opportunity

ÿ Microfinance institution in Somaliland is little so we need more microfinance to establish

all regions in Somaliland

ÿ Microfinance should be encourage the women because women all most poor people so

government must look after women

ÿ There is no risk in microfinance activity