Microfinancing – friend or foe?
My great grandfather was a rich farmer in a village circa thirty kilometers away from the financial metropolis Zurich. He owned half the village and a lot of people were indebted to him because they had taken out loans from him. The family chronicles remain silent on whether he was fair or greedy as money-lender.
A hundred years have past since then. Raiffeisen Bank, founded at the end of the nineteenth century, gave poor rural households, especially in Switzerland and Germany, fair credit conditions. Nowadays, local profiteers are a thing of the past in most parts of the Western world. Similar to that Zurich village, access to affordable financial services is essential for people in rural regions in developing countries: For example, to build up a business or make an expensive investment.
Ever since Muhammad Yunus discovered that poor, Indian families reliably pay back their loans with interest, and can thereby escape poverty on a medium term, microcredits have been a success story. The tool is now used in development aid throughout the world. That corresponds with a total of circa 25 billion US dollars worldwide paid out to circa 140 million customers.
Yet for some time now, critical voices can also be heard. For example, in a BBC News report last December entitled "India's micro-finance suicide epidemic," in response to the increasing number of highly indebted Indians who see suicide as the only way out of their situation. A study by the Microcredit Summit Campaign, on the contrary, stated in January 2011, that "Microcredit lifted 10 million Bangladeshis out of poverty between 1990 and 2008." What is the truth here?
Commercialization: Chance or disaster?
It is clear that the microfinance industry has changed fundamentally since its founding. Most multinational banks have discovered the business over the past fifteen years, and have thereby brought about a trend that has gone as far as commercialization. Rather than the original non-profit institutions, it is increasingly profit-making firms who have become involved in the microfinance market. Their promoters argue, "Without commercialization, microfinance does not grow fast enough." After all, today's microfinance industry still only reaches one in ten of those affected. Even traditionalists, such as Muhammad, can hardly counter this argument. His Grameen Bank is, by the way (like most MFIs), not greedy for profit but in any case, a profitable enterprise. Commercial expertise is also required, when along with microcredits, services such as savings and insurance are to be offered in a secure context. Nonetheless, one-sided commercialization harbors dangers, as proven by countless negative examples. In Andrha Pradesch, for example, an unhealthy competition in 2010 led to unstable awarding of credits. The extreme indebtedness of many households led to a collapse of repayment discipline and thus, the system.
High interest and low transparency
Another critique is that commercial suppliers demand very high interest: 100 percent annually (APR) after tax, or even more. This strategy, oriented on fast growth and high returns, disregards customer orientation and long-term development. Fast and high profits can only be achieved with the "middle-class poor." A study carried out in South Africa, for example, showed that the majority of customers at the poverty line, who nonetheless had a career position, could also develop positively with a high interest rate. The original concept of MFIs, however, aims at the bottom of the pyramid (BoP): Old and handicapped people, widows, and orphans, for example, do not have the possibility to pay interest that covers the effective costs.
A fundamental problem is the lack of transparency in terms of interest rates. This makes it almost impossible for customers to compare MFI loans and choose the most suitable partner. In addition, the choice in rural regions is certainly not that great until now. Perhaps a Kenyan small-animal breeder has the choice between a MFI with 40 percent APR or a local profiteer who demands twice as much, or more. Many customers also fall into the trap of debt because they take out several loans at different MFIs. Here, MFIs must appeal to their own responsibility and consider their customers' financial possibilities. Customers must also be explained all terms when signing a loan contract. In the end, it was similar mechanisms as in the 2008 sub-prime-mortgage meltdown that led to disaster in Andrash Pradesh.
Professional MFIs with select partners
Despite all criticism, there is no real doubt about the necessity of professional microfinance services. They are required when at issue is supporting more customers and regions; and mainly, offering additional services, such as building up of savings for emergencies, and insurance for lost harvests and other risks.Criticism of MFIs must, nonetheless, be accommodated. Partner institutions and banks must be carefully chosen and monitored. And final customers must be reviewed in terms of suitable loan amounts, and they must be explained the mechanisms of the system.
Source: sun-connect 6 | July 2011 (p.12)