Microfinance institutions (MFIs) provide financial services to the poor, who are normally excluded from the formal banking sector. The failures in reaching out to the poor by government schemes had generated a group of MFIs to engage in income-generating activities due to inadequate provision of savings, credit, and insurance facilities in several countries, especially in Bolivia, Bangladesh, and Indonesia. In 2006 Grameen Bank—the first microcredit institution, started with loans of less than $1 each to 42 destitute Bangladeshis—had grown to reach 7 million clients. Over the years, Grameen Bank is credited with proving that “the poor are bankable,” and the Grameen model has been copied in more than 40 countries.
Currently, there are 3,316 MFIs reportedly reaching over 133 million clients by the end of 2006, and loans to 92.9 million poorest clients benefit a total of 464.6 million people, including both clients and their family members. In terms of ownership patterns, the microfinance institutions provide different structures such as government-owned (rural credit cooperatives in China), socially minded shareholders (transformed NGOs in Latin America), member-owned (credit unions in west Africa), and profit-maximizing shareholders (microfinance banks in eastern Europe).
In the early stages, the MFIs had only concentrated their activities on micro credit, but changed to a range of services in due course. The MFIs introduced concepts such as group-lending contract, character-based lending, short-term repeat loans, and incentives for loan repayments. The extensive Microcredit Summit Campaign Report 2007 argues that although microfinance is not a panacea, it is still a powerful tool to fight global poverty and works well with other development interventions that promote health, nutrition, housing, democracy, and education, offering dignity and empowerment to the very poor.
The flexibility in repayment options allows borrowers to repay out of existing income, freeing the borrower to invest the loan in relation to their needs. Many microfinance institutions permit people to access useful lump sums through loans and allow borrowers to repay the loan in small, frequent, manageable installments, which is further supported by quick access to larger repeat loans. Most of these institutions are successful financially due to high repayment rates and an enhanced awareness of the levels of subsidy. These features make microfinance institutions different from small-scale commercial and informal financial institutions and from large government sponsored schemes, and are either independent of government and/or have a high degree of autonomy from bureaucrats and politicians. However, a better understanding of the financial service preferences and behaviors of the poor and poorest is still required to expand the scope of microfinance in addressing the concerns about welfare implications of MFIs.
In the 1990s a debate emerged around two leading views in microfinance services available to the poor—financial systems approach and poverty lending approach, both of which share a commitment to make these services available to the poor. The financial system approach framework is based on the principles of financial self-sufficiency, as seen in institutions such as Banco Solidario (BancoSol) in Bolivia and the Bank Rakyat Indonesia (BRI). The poverty lending approach focuses on credit and other services funded by donor and concessional funds as an important mechanism for poverty reduction. This approach is interested in improving the well-being of participants and their families. The examples of this category are Bangladesh Rural Advancement Committee (BRAC) and FINCAstyle village banking programs in Latin America. However, this debate is largely resolved now and the microfinance sector is adopting operating on commercial lines or systematically reducing reliance on interest rate subsidies and/or aid agency financial support. This is evident by the experience in Bangladesh where the Grameen Bank has shifted from its classic “Grameen I” group—lending to the poor model—to “Grameen II,” which is much closer to the financial systems model.
Recently, the growth in new products such as smart cards and the use of technology in developing new points of sale has been helping microfinance institutions to enhance their outreach. Even the conventional banking institutions have entered into the provision of microfinance in a big way. The private sector has built a significant presence in microfinance operations and the microfinance institutions are successfully raising commercial funds from the capital market and social investors.
- Denis T. Carpio, Financing Micro, Small, and Medium Enterprises: An Independent Evaluation of IFC’s Experience With Financial Intermediaries in Frontier Countries (International Finance Corporation, World Bank Group, 2008);
- Daley-Harris, “State of the Microcredit Summit Campaign Report 2007,” (Microcredit Summit Campaign, 2007);
- Hulme and T. G. Arun, eds., Microfinance: A Reader (Routledge, 2008);
- Ingrid Matthäus-Maier and D. Von Pischke, New Partnerships for Innovation in Microfinance (Springer, 2008);
- Craig McIntosh, Alain de Janvry, and Elisabeth Sadoulet, “How Rising Competition Among Microfinance Institutions Affects Incumbent Lenders,” Economic Journal (v.115/506, 2005);
- Morduch, “The Microfinance Promise,” Journal of Economic Literature (v.37/4, 1999);
- Maria E. Pagura, Expanding the Frontier in Rural Finance: Financial Linkages and Strategic Alliances (Practical Action, 2008);
- Rutherford, The Poor and Their Money (Oxford University Press, 1999).
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