Community-based savings bank in Cambodia. The Kingdom of Cambodia ( formerly known as Kampuchea (, transliterated: Preăh Réachéanachâkr Kâmpŭchea) is a country in South East There is a rich variety of financial institutions serving poor people. Photo by Brett Matthews.

Microfinance refers to the provision of financial services to low-income clients, including the self-employed. ^[1] The term also refers to the practice of sustainably delivering those services. Sustainability, in a general sense is the capacity to maintain a certain process or state indefinitely

More broadly, it refers to a movement that envisions “a world in which as many poor and near-poor households as possible have permanent access to an appropriate range of high quality financial services, including not just credit but also savings, insurance, and fund transfers. ”^[2]

Boundaries

Theoretically, microfinance encompasses any financial service used by poor people, including those they access in the informal economy, such as loans from a village moneylender. In Economics, the term informal economy (or second economy in the South African context refers to all economic activities that fall outside the formal In practice however, the term is usually only used to refer to institutions and enterprises whose goals include both profitability and reducing the poverty of their clients.

Microfinancial services are needed everywhere, including the developed world. However, in developed economies intense competition within the financial sector, combined with a diverse mix of different types of financial institutions with different missions, ensures that most people have access to some financial services. In Financial economics, a financial institution acts as an agent that provides Financial services for its clients or members Efforts to transfer microfinance innovations such as solidarity lending from developing countries to developed ones have met with little success. Solidarity lending is an important building block of Microfinance.

Microfinance can also be distinguished from charity. It is better to provide grants to families who are destitute, or so poor they are unlikely to be able to generate the cash flow required to repay a loan. This situation can occur for example, in war zone or after a natural disaster.

The Challenge

Traditionally, banks have usually not provided financial services to clients with little or no cash income. Banks must incur substantial costs to managing a client account, regardless of how small the sums of money involved. For example, the total revenue from delivering one hundred loans worth $1,000 each will not differ greatly from the revenue that results from delivering one loan of $100,000. But it takes nearly a hundred times as much work and cost to manage a hundred loans as it does to manage one. A similar equation resists efforts to deliver other financial services to poor people. There is a break-even point in loan and deposit sizes below which banks lose money on each transaction they make. In Economics, specifically Cost accounting, the break-even point (BEP is the point at which cost or expenses and revenue are equal there is no net loss or gain Poor people usually fall below it.

In addition, most poor people have few assets that can be secured by a bank as collateral. As documented extensively by Hernando de Soto and others, even if they happen to own land in the developing world, they may not have effective title to it. Hernando de Soto (born 1941 - 06-02) is a Peruvian Economist known for his work on the Informal economy and on the importance of Title is a legal term for a bundle of rights in a piece of property in which a party may own either a legal interest or an equitable interest The rights This means that the bank will have little recourse against defaulting borrowers.

Seen from a broader perspective, it has long been accepted that the development of a healthy national financial system is an important goal and catalyst for the broader goal of national economic development (see for example Alexander Gerschenkron, Paul Rosenstein-Rodan, Joseph Schumpeter, Anne Krueger etc. The field of finance refers to the concepts of Time, Money and Risk and how they are interrelated Economic development is the development of economic wealth of countries or regions for the well-being of their inhabitants Alexander Gerschenkron (* 1904 in Odessa, † 26 october 1978 in Cambridge, Massachusetts) was a Russian born American Paul Narcyz Rosenstein-Rodan (1902 – 1985 was an Austrian economist born in Kraków, who was trained in the Austrian tradition under Hans Mayer Joseph Alois Schumpeter ( February 8, 1883 &ndash January 8, 1950) was an Economist and Political scientist born in (The following is almost verbatim from Anne O Krueger -- Biographical Information copyrighted by the International Monetary Fund used under Fair use; see) ). However, national planners and experts focus their attention mainly on developing a commercial banking sector dealing in high-value transactions, and often neglect the delivery of services to households of limited means, even though these households comprise the large majority of their populations. A commercial bank is a type of Financial intermediary and a type of Bank.

Because of these difficulties, when poor people borrow they often visit their relatives or the ubiquitous local moneylender, whose interest rates can be very high. A moneylender offers small Personal loans at high rates of interest, usually higher rates than the market rate charged on Credit cards or on An analysis of 28 studies of informal moneylending rates in 14 countries in Asia, Latin America and Africa concluded that 76% of moneylender rates exceed 10% a month, including 22% that exceed 100% a month. Moneylenders usually charge higher rates to poorer borrowers than to less poor ones. ^[3] While moneylenders are often demonized and accused of usury, their services are convenient and fast, and they can be very flexible when borrowers run into problems. Usury (ˈjuːʒəri comes from the Medieval Latin usuria, "interest" or "excessive interest" from the Latin usura "interest" Hopes of quickly putting them out of business have proven unrealistic, even in places where microfinance institutions are very active.

Over the past centuries practical visionaries from the Franciscan monks who founded the community-oriented pawnshops of the fifteenth century, to the founder of the credit union movement in the nineteenth century (Friedrich Wilhelm Raiffeisen) and the founders of the microcredit movement in the 1970s (such as Muhammad Yunus) have tested practices and built institutions designed to bring the kinds of livelihood opportunities and risk management tools that financial services provide to the doorsteps of poor people. The term Franciscan is commonly used to refer to members of Catholic A pawnbroker is an individual or business entity that offers monetary loans in exchange for an item of value to the given pawn broker A credit union is a Cooperative Financial institution that is owned and controlled by its members and operated for the purpose of promoting thrift providing credit Friedrich Wilhelm Raiffeisen ( May 3, 1818, Hamm (Sieg - March 11, 1888, Heddesdorf currently known as Neuwied, This article is specific to small loans For financial services to the poor see Microfinance. Muhammad Yunus (মুহাম্মদ ইউনুস pronounced bn-Latn ''Muhammôd Iunus'' (born 28 June 1940 is a Bangladeshi Banker and Economist ^[4] While the success of Grameen Bank (which now serves over 7 million poor Bangladeshi women) has inspired the world, it has proved difficult to replicate this success in practice. The Grameen Bank (গ্রামীণ ব্যাংক is a Microfinance organization and Community development bank started in Bangladesh that In nations with lower population densities, meeting the operating costs of a retail branch by serving nearby customers has proven considerably more challenging.

Although much progress has been made, the problem has not been solved yet, and the overwhelming majority of people who earn less than $1 a day, especially in the rural areas, continue to have no practical access to formal sector finance.

Key principles of microfinance

Key principles of microfinance were developed in 2004 by Consultative Group to Assist the Poor (CGAP) and endorsed by the Group of Eight leaders at the G8 Summit on June 10, 2004. The Consultative Group to Assist the Poor (CGAP is a consortium of 33 public and private development agencies working together to expand access to Financial services Among the key principles, summarizing a century and a half of development practice, are the following:

• 1. Poor people need a variety of financial services, not just loans.
• 2. Microfinance can pay for itself, and must do so if it is to reach very large numbers of poor people.
• 3. Microfinance is about building permanent local financial institutions.
• 4. The job of government is to enable financial services, not to provide them.
• 5. The key bottleneck is the shortage of strong institutions and managers. ^[5]

More generally, the Principles assert that “Microfinance means building financial systems that serve the poor. ” Financial systems include strong financial institutions but also much more: more competitive financial markets, better government regulatory services and better complementary services (practitioner education, auditing, etc. )

Financial needs of poor people

Financial needs and financial services.

In developing economies and particularly in the rural areas, many activities that would be classified in the developed world as financial are not monetized: that is, money is not used to carry them out. Monetization is the process of converting or establishing something into Legal tender. Money is anything that is generally accepted as Payment for Goods and services and repayment of Debts. Almost by definition, poor people have very little money. But circumstances often arise in their lives in which they need money or the things money can buy.

In Stuart Rutherford’s recent book The Poor and Their Money, he cites several types of needs:^[6]

• Lifecycle Needs: such as weddings, funerals, childbirth, education, home-building, widowhood, old age.
• Personal Emergencies: such as sickness, injury, unemployment, theft, harassment or death.
• Disasters: such as fires, floods, cyclones and man-made events like war or bulldozing of dwellings.
• Investment Opportunities: expanding a business, buying land or equipment, improving housing, securing a job (which often requires paying a large bribe), etc.

Poor people find creative and often collaborative ways to meet these needs, primarily through creating and exchanging different forms of non-cash value. Common substitutes for cash vary from country to country but typically include livestock, grains, jewellery and precious metals.

Ways poor people manage their money

Stuart Rutherford. The Poor and Their Money.

Rutherford argues that the basic problem poor people as money managers face is to gather a ‘usefully large’ amount of money. Building a new home may involve saving and protecting diverse building materials for years until enough are available to proceed with construction. Children’s schooling may be funded by buying chickens and raising them for sale as needed for expenses, uniforms, bribes, etc. Because all the value is accumulated before it is needed, this money management strategy is referred to as ‘saving up’.

Often people don’t have enough money when they face a need, so they borrow. A poor family might borrow from relatives to buy land, from a moneylender to buy rice, or from a microfinance institution to buy a sewing machine. Since these loans must be repaid by saving after the cost is incurred, Rutherford calls this ‘saving down’. Rutherford's point is that microcredit is addressing only half the problem, and arguably the less important half: poor people borrow to help them save and accumulate assets. Microcredit institutions should fund their loans through savings accounts that help poor people manage their myriad risks.

Stuart Rutherford. The Poor and Their Money.

Most needs are met through mix of saving and credit. A benchmark impact assessment of Grameen Bank and two other large microfinance institutions in Bangladesh found that for every $1 they were lending to clients to finance rural non-farm micro-enterprise, about $2. The Grameen Bank (গ্রামীণ ব্যাংক is a Microfinance organization and Community development bank started in Bangladesh that A micro-enterprise is a type of Small business. A micro-enterprise is defined as a business having 5 or fewer employees and a seed capital of not more than $35000 50 came from other sources, mostly their clients’ savings. ^[7] This parallels the experience in the West, in which family businesses are funded mostly from savings, especially during start-up.

Recent studies have also shown that informal methods of saving are very unsafe. For example a study by Wright and Mutesasira in Uganda concluded that “those with no option but to save in the informal sector are almost bound to lose some money – probably around one quarter of what they save there. ”^[8]

The work of Rutherford, Wright and others has caused practitioners to reconsider a key aspect of the microcredit paradigm: that poor people get out of poverty by borrowing, building microenterprises and increasing their income. The new paradigm places more attention on the efforts of poor people to reduce their many vulnerabilities by keeping more of what they earn and building up their assets. While they need loans, they may find it as useful to borrow for consumption as for microenterprise. A safe, flexible place to save money and withdraw it when needed is also essential for managing household and family risk.

Current scale of microfinance operations

No systematic effort to map the distribution of microfinance has yet been undertaken. A useful recent benchmark was established by an analysis of ‘alternative financial institutions’ in the developing world in 2004. ^[9] The authors counted approximately 665 million client accounts at over 3,000 institutions that are serving people who are poorer than those served by the commercial banks. Of these accounts, 120 million were with institutions normally understood to practice microfinance. Reflecting the diverse historical roots of the movement, however, they also included postal savings banks (318 million accounts), state agricultural and development banks (172 million accounts), financial cooperatives and credit unions (35 million accounts) and specialized rural banks (19 million accounts). A savings bank is a Financial institution whose primary purpose is accepting Savings deposits A credit union is a Cooperative Financial institution that is owned and controlled by its members and operated for the purpose of promoting thrift providing credit

Regionally the highest concentration of these accounts was in India (188 million accounts representing 18% of the total national population). India, officially the Republic of India (भारत गणराज्य inc-Latn Bhārat Gaṇarājya; see also other Indian languages) is a country The lowest concentrations were in Latin American and the Caribbean (14 million accounts representing 3% of the total population) and Africa (27 million accounts representing 4% of the total population). Considering that most bank clients in the developed world need several active accounts to keep their affairs in order, these figures indicate that the task the microfinance movement has set for itself is still very far from finished.

By type of service “savings accounts in alternative finance institutions outnumber loans by about four to one. This is a worldwide pattern that does not vary much by region. ”^[10]

An important source of detailed data on selected microfinance institutions is the MicroBanking Bulletin. At the end of 2006 it was tracking 704 MFIs that were serving 52 million borrowers ($23. 3 billion in outstanding loans) and 56 million savers ($15. 4 billion in deposits). Of these clients, 70% were in Asia, 20% in Latin America and the balance in the rest of the world. ^[11]

As yet there are no studies that indicate the scale or distribution of ‘informal’ microfinance organizations like ROSCAs and informal associations that help people manage costs like weddings, funerals and sickness. A Rotating Savings and Credit Association or ROSCA is a group of individuals who agree to meet for a defined period of time in order to save and borrow together Numerous case studies have been published however, indicating that these organizations, which are generally designed and managed by poor people themselves with little outside help, operate in most countries in the developing world. ^[12]

"Inclusive financial systems"

The microcredit era that began in the 1970s has lost its momentum, to be replaced by a ‘financial systems’ approach. While microcredit achieved a great deal, especially in urban and near-urban areas and with entrepreneurial families, its progress in delivering financial services in less densely populated rural areas has been slow. Another major goal of the microcredit movement was to put the traditional moneylender, who typically charges at least 10% a month and often much more, out of business. There is little evidence of progress towards this goal.

The new financial systems approach pragmatically acknowledges the richness of centuries of microfinance history and the immense diversity of institutions serving poor people in developing world today. It is also rooted in an increasing awareness of diversity of the financial service needs of the world’s poorest people, and the diverse settings in which they live and work.

Brigit Helms in her book 'Access for All: Building Inclusive Financial Systems', distinguishes between four general categories of microfinance providers, and argues for a pro-active strategy of engagement with all of them to help them achieve the goals of the microfinance movement. ^[13]

Informal financial service providers

These include moneylenders, pawnbrokers, savings collectors, money-guards, ROSCAs, ASCAs and input supply shops. Because they know each other well and live in the same community, they understand each other’s financial circumstances and can offer very flexible, convenient and fast services. These services can also be costly and the choice of financial products limited and very short-term. Informal services that involve savings are also risky; many people lose their money.

Member-owned organizations

These include self-help groups, credit unions, and a variety of hybrid organizations like ‘financial service associations’ and CVECAs. A self-help group (SHG is a village-based financial intermediary usually composed of between 10-15 local women A CVECA is a self-reliant village savings and credit bank (from the French Caisse Villageoise d'Epargne et de Crédit Autogérée) Like their informal cousins, they are generally small and local, which means they have access to good knowledge about each others’ financial circumstances and can offer convenience and flexibility. Since they are managed by poor people, their costs of operation are low. However, these providers may have little financial skill and can run into trouble when the economy turns down or their operations become too complex. Unless they are effectively regulated and supervised, they can be ‘captured’ by one or two influential leaders, and the members can lose their money.

NGOs

The Microcredit Summit Campaign counted 3,133 of these microcredit NGOs lending to about 113 million clients by the end of 2005. ^[14] Led by Grameen Bank and BRAC in Bangladesh, Prodem in Bolivia, and FINCA International, headquartered in Washington, DC, these NGOs have spread around the developing world in the past three decades. The Grameen Bank (গ্রামীণ ব্যাংক is a Microfinance organization and Community development bank started in Bangladesh that ( Bengali: বাংলাদেশ inc-Latn Bangladesh) officially The Republic of Bolivia (República de Bolivia) named after Simón Bolívar, is a Landlocked country in central South America. The Foundation for International Community Assistance (FINCA International is a Non-profit, Microfinance organization founded by John Hatch in 1984 They have proven very innovative, pioneering banking techniques like solidarity lending, village banking and mobile banking that have overcome barriers to serving poor populations. Solidarity lending is an important building block of Microfinance. Village Banking is a Microcredit methodology developed by FINCA International founder John Hatch. Mobile banking (also known as M-Banking mbanking SMS Banking etc However, with boards that don’t necessarily represent either their capital or their customers, their governance structures can be fragile, and they can become overly dependent on external donors.

Formal financial institutions

In addition to commercial banks, these include state banks, agricultural development banks, savings banks, rural banks and non-bank financial institutions. They are regulated and supervised, offer a wider range of financial services, and control a branch network that can extend across the country and internationally. However, they have proved reluctant to adopt social missions, and due to their high costs of operation, often can’t deliver services to poor or remote populations.

With appropriate regulation and supervision, each of these institutional types can bring leverage to solving the microfinance problem. For example, efforts are being made to link self-help groups to commercial banks, to network member-owned organizations together to achieve economies of scale and scope, and to support efforts by commercial banks to ‘down-scale’ by integrating mobile banking and e-payment technologies into their extensive branch networks.

Criticism

Some proponents of microfinance have asserted, without offering credible evidence, that microfinance has the power to single-handedly defeat poverty. This assertion has been the source of considerable criticism. ^[15] In addition, research on the actual effectiveness of microfinance as a tool for economic development remains slim, in part owing to the difficulty in monitoring and measuring this impact. ^[16]

There has also been much criticism of the high interest rates charged to borrowers. The real average portfolio yield cited by the a sample of 704 microfinance institutions that voluntarily submitted reports to the MicroBanking Bulletin in 2006 was 22. 3% annually. However, annual rates charged to clients are higher, as they also include local inflation and the bad debt expenses of the microfinance institution. ^[17] Muhammad Yunus has recently made much of this point, and in his latest book^[18] argues that microfinance institutions that charge more than 15% above their long-term operating costs should face penalties. Muhammad Yunus (মুহাম্মদ ইউনুস pronounced bn-Latn ''Muhammôd Iunus'' (born 28 June 1940 is a Bangladeshi Banker and Economist

The role of donors has also been questioned. The Consultative Group to Assist the Poor (CGAP) recently commented that "a large proportion of the money they spend is not effective, either because it gets hung up in unsuccessful and often complicated funding mechanisms (for example, a government apex facility), or it goes to partners that are not held accountable for performance. In some cases, poorly conceived programs have retarded the development of inclusive financial systems by distorting markets and displacing domestic commercial initiatives with cheap or free money. "^[19]

There has also been criticism of microlenders for not taking more responsibility for the working conditions of poor households, particularly when borrowers become quasi-wage labourers, selling crafts or agricultural produce through an organization controlled by the MFI. The desire of MFIs to help their borrower diversify and increase their incomes has sparked this type of relationship in several countries, most notably Bangladesh, where hundreds of thousands of borrowers effectively work as wage labourers for the marketing subsidiaries of Grameen Bank or BRAC. ( Bengali: বাংলাদেশ inc-Latn Bangladesh) officially Critics maintain that there are few if any rules or standards in these cases governing working hours, holidays, working conditions, safety or child labour, and few inspection regimes to correct abuses. ^[20] Some of these concerns have been taken up by unions and socially responsible investment advocates. Socially responsible investing, also known as sustainable investing or ethical investing describes an Investment Strategy which seeks to maximize both Financial

Bibliography

Following is a selected bibliography

• Adams, Dale W. , Douglas H. Graham & J. D. Von Pischke (eds. ). Undermining Rural Development with Cheap Credit. Westview Press, Boulder & London, 1984.
• Branch, Brian & Janette Klaehn. Striking the Balance in Microfinance: A Practical Guide to Mobilizing Savings. PACT Publications, Washington, 2002.
• Christen, Robert Peck, Jayadeva, Veena & Richard Rosenberg. Financial Institutions with a Double Bottom Line. Consultative Group to Assist the Poor, Washington 2004.
• Gibbons, David. The Grameen Reader. Grameen Bank, Dhaka, 1992.
• Helms, Brigit. Access for All: Building Inclusive Financial Systems. Consultative Group to Assist the Poor, Washington, 2006.
• Hirschland, Madeline (ed. ) Savings Services for the Poor: An Operational Guide. Kumarian Press Inc. , Bloomfield CT, 2005.
• Khandker, Shahidur R. Fighting Poverty with Microcredit, Bangladesh edition, The University Press Ltd, Dhaka, 1999.
• Ledgerwood, Joanna. The Microfinance Handbook.
• Raiffeisen, FW (translated from the German by Konrad Engelmann). The Credit Unions. The Raiffeisen Printing & Publishing Company, Neuwied on the Rhine, Germany, 1970.
• Rutherford, Stuart. The Poor and Their Money. Oxford University Press, Delhi, 2000.
• Todd, Helen. Women at the Center: Grameen Borrowers After One Decade. University Press Ltd. , Dhaka, 1996.
• Wolff, Henry W. People’s Banks: A Record of Social and Economic Success. P. S. King & Son, London, 1910.
• Maimbo, Samuel Munzele & Dilip Ratha (eds. ) Remittances: Development Impact and Future Prospects. The World Bank, 2005.
• Wright, Graham A. N. Microfinance Systems: Designing Quality Financial Services for the Poor. The University Press, Dhaka, 2000.
• United Nations Department of Economic Affairs and United Nations Capital Development Fund. Building Inclusive Financial Sectors for Development. United Nations, New York, 2006.
• Yunus, Muhammad (with Alan Jolis) . Banker to the Poor: Micro-Lending and the Battle Against World Poverty. PublicAffairs, New York, 1999.

See also

• bank
• credit union
• microcredit
• microinsurance
• pawnbroker
• ROSCA
• savings bank

Notes

External links

• Rural Finance Program at The Ohio State University
• UNCDF Microfinance Distance Learning Program