Introduction to Microfinance

The following sections are included:

• LIST OF CO-AUTHORS
• CONTENTS
• LIST OF FIGURES
• LIST OF TABLES
• LIST OF BOXES

The inequality of wealth distribution across the globe is no secret. One out of every three people in the world live on less than $3.10 per day. Nearly one in 10 lives in extreme poverty, which according to the World Bank is an income of less than $1.90 per day. The global distribution of poverty is uneven as well, with more than 75% of those living in extreme poverty living in South Asia or Sub-Saharan Africa. This sobering fact has driven various organizations such as the United Nations, World Bank, and many non-governmental organizations, or NGOs, to initiate programs targeted at reducing poverty. Microfinance is just one of many innovative tools in the global effort to shrink the wealth gap.

Poverty continues to affect billions of lives across the globe. Microfinance is but one tool of many that strives to alleviate poverty. Specifically, microfinance serves the demand the poor have for financial services. The poor have been traditionally excluded from formal financial services, but through innovative financial products, such as group lending, microfinance institutions have been able to address the challenges in lending to the poor while delivering products—microcredit, microsavings, insurance, and more—that can help clients lift themselves and their families out of poverty.

With the help of network organizations, microfinance investment vehicles, donors, and technical support providers, microfinance institutions attempt to reach the underserved and to include them as fully as possible in financial systems around the world. This effort has grown from a handful of organizations serving a few clients to many thousands of microfinance institutions reaching hundreds of millions of low-income people across the globe.

The following chapters will take a closer look at poverty, microfinance, the industry, the impact of microfinance on the poor, and the key players that make microfinance possible.

This chapter seeks to explore the concept of poverty and shed light on the daily lives and challenges of the world’s poor. By the end, you should be able to answer the following questions: How do the poor manage their income and expenses? What does poverty mean? What are overall patterns of poverty around the world? And why is it so hard to escape poverty?

There is a cyclical pattern to poverty. Without money, you cannot access education, and without an education you cannot get a high-paying, secure job, and without such a job, you cannot make much money. At the same time, without nutritious food or clean water, you cannot maintain good health and will fall ill, but without money you cannot access healthcare, and when you are ill you cannot work to make money. Similarly, without enough money to make business investments, you will have to make do continuing to earn a low wage, but if you continue at that low wage, you will never be able to make business investments that can improve your income and your financial stability and security.

It is these investments in health, education, and finances that the poor lack access to, and in part is what keeps them from pulling themselves out of poverty. The poor are generally incredibly hard working, but without access to financial mechanisms for saving, insuring, borrowing and investing, they have only little to show for their hard work. What microfinance provides more than anything else is simply access to services that enable and empower the poor by giving them financial flexibility for managing and growing their incomes and securing assets. The rest of this book will investigate the way microfinance works and how (and in fact whether) it serves the poor.

Half the world is unbanked. The unbanked do not use any type of formal financial service at all. Why? What has kept the poor from opening formal bank accounts to save for retirement, from getting health insurance or loans to build new businesses? The assumption used to be that the poor lacked the resources and needs. In Chapter 2, though, we saw that the poor can and do use a wide array of financial services, but largely rely on informal means. If hundreds of millions of people want these services, why do not banks and insurance companies offer them? Why does nearly everyone in Finland, Singapore and Australia have bank accounts, but more than 95% of people in Turkmenistan, Niger and Cambodia do not?

Formal financial services are often missing in poorer areas. Before the emergence of microfinance institutions, the poor for the most part had only informal options for financial services. As we discussed in Chapter 3, to most banks and other mainstream financial service providers, poorer populations appeared to lack enough assets and be too costly and risky to serve profitably. Yet even without access to formal financial services, people participate in creative and innovative ways to accumulate savings and access credit and insurance through the informal economy.

The poor around the world face financial intermediation needs perhaps even more central for their everyday lives than for the rich. With formal finance out of reach, they have developed a creative array of informal systems to fill the gap. They participate in ROSCAs and ASCAs in order to obtain large lump sums and as means of insurance. Deposit collectors facilitate savings for the poor and moneylenders and interlinked transactions expand their options to borrow. While some moneylenders and middlemen are justly criticized as abusing their power over people with few alternatives, many others are creating value for the poor by providing flexible and personalized services tailored exactly for their needs and situations.

Nevertheless, informal systems are by no means perfect. With their very informality and small scale come inherent weaknesses, risks and challenges for the poor. As we will explore through the rest of the book, innovative MFIs continue to look for inspiration in the way these many informal schemes function, combining some practices drawn from them with infrastructures from formal finance in quests to design more accessible and useful financial services for the poor.

Microlending is a primary component of microfinance, and one of the most well known activities associated with the industry. Microlending has two basic models: group lending and individual lending. Due to the publicity of Muhammad Yunus and Grameen Bank’s 2006 Nobel Prize, many people associate microfinance directly with the group-lending model, although as we have seen the industry stems far beyond lending to financial services of all sorts.

While group lending is a traditional trademark of MFIs, more and more organizations are modifying their lending practices to reflect developments in the field and address key limitations of group lending. Theoretically, joint liability group lending practices can transfer some risks and transactions costs from MFIs to borrowers. Yet the joint liability scheme has come under increasing scrutiny regarding not only whether or not it is actually effective at reducing default risk, but also its potential for negative economic, social and psychological implications for already struggling poor clients. Other techniques such as progressive lending, frequent installment repayments, and periodic public meetings as a means to exert social pressure have emerged as apparently just as (or more?) effective in overcoming the challenges of information asymmetries, adverse selection, moral hazard and limited liability. The benefits, however, come with costs too. Public group meetings can be costly for clients to attend due to time and transportation expenses. Group and individual lending practices will surely continue to evolve and improve with the maturity of the industry as a whole.

Although there is an industry wide trend towards individual lending, due to its potential profitability for MFIs and greater flexibility for clients, it tends to not focus on serving the poorest of the poor. Individual loans are often larger and targeted towards those with bigger businesses, more assets and more income. Indeed, as discussed in Chapter 8, there is significant debate in the microfinance industry about the potential for so-called mission drift. This arises from the tension between, on one hand, the very real challenges of serving the very poorest in tough economic, political and physical environments and, on the other hand, the drive towards sustainable profits that could attract more investment and resources that could enable expanding services to more people.

More broadly, as we will see in later chapters some MFIs have been widely criticized for over-promoting borrowing in general, and as not much different than loan sharks in leading some of society's most economically vulnerable into endless cycles of debt from which they cannot escape. As one observer put the concern, "debts are bonds" binding the poor into poverty. Thankfully, as we will explore next in Chapter 6, microfinancial services today have grown far more diverse than just loans, offering the poor a wide array of innovative and cost-effective financial intermediation tools to help them navigate their very real day-to-day financial needs and challenges.

Services provided by microfinance institutions (MFIs) extend well beyond lending, and encompass a wide range of financial intermediation. As we saw in Chapter 2, just like most of us, the poor need a portfolio of services for various purposes to navigate the financial complexities of their daily lives. MFIs continue to look for ways to better serve their clients in sustainable ways. Hence, the diverse array of additional services various MFIs offer aims to add not only revenues but also social returns by improving the lives of their clientele.

You may know the famous quote of the Chinese revolutionary Chairman Mao Zedong that “women hold up half the sky.” Clearly, he had not yet heard of microfinance. Most microfinance clients are women, three out of every four worldwide. Some microfinance institutions (MFIs), including some of the very largest in the world, exclusively serve women. Of Bandhan’s 5.4 million clients in India, 100% are women. So are every single one of BFIL’s 6 million clients. Fully 96% of Grameen Bank’s 6.7 million members were women, as are 98% of the CARD Bank, Inc.’s clients in the Philippines, and 94% of Compartamos Banco’s borrowers in Mexico. Indeed, the majority of microfinance institutions provide services expressly designed to address women’s needs. Some MFIs like Women’s World Banking and Pro Mujer highlight their gender focus right in their names.

Microfinance, as an industry, has rapidly evolved since the mid-1990s. Changes were so fundamental they amounted to what Harvard University’s Marguerite Robinson called the “microfinance revolution.” What was initially a niche sector of mostly small, non-profit, donor-dependent efforts aimed at poverty alleviation, is today a full-fledged global industry. The large majority of microfinance clients worldwide are customers of large-scale, self-sustainable microfinance institutions (MFIs) not reliant on subsidies. Indeed, most of the largest MFIs now are commercial firms seeking profit for owners and investors. They raise funds in international financial markets rather than relying on subsidies, and offer a variety of financial products, well beyond just microcredit.

We have seen that commercialized, profit-seeking MFIs charge interest rates that can come down over time as scale and efficiency in competitive markets put downward pressure on prices. Profit-seeking and institutional scaling often lead MFIs to legally transform into regulated institutions, which then face additional shareholder and regulatory pressures to charge less than nonregulated peers. As a result, global microfinance interest rates and fees for client services have fallen steadily as the industry and regulatory systems have matured over the past decades. But not everywhere. Much work remains to fully realize the double bottom line potential of commercial microfinance.

Look at a typical microfinance institution’s website and you will find heartwarming stories about people who managed to dig themselves out of poverty and into prosperity. Often, these narratives, like the one in Box 9.1, suggest people did not do it just for themselves, but also for their children and communities, so that they, too, could have a better future.

The following sections are included:

• REFERENCES
• INDEX