B. P. Lagua: Improving the Microfinance Model

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Oct 2016
Global , October, 31 2016 - Micro lending and microfinance are not perfect solutions but cannot be overlooked in the war against poverty. What is important is to address its weaknesses and shortcomings and to move forward with solutions that will ensure that the impact to a bigger portion of participants will be positive by way of a better quality of life.

A recent article at The Economist discussed the resurgence of micro lending despite the initial problems encountered after the first wave of issues confronting the sector. The number of borrowers worldwide grew by 16% between 2014 and 2015, to 130M. Interestingly, the Philippines ranked 6th in terms of largest number of active microfinance borrowers. The first five in rank order are as follows: India, Bangladesh, Vietnam, Mexico and Peru. In terms of active borrowers as a percentage of total population, the Philippines ranked only eight. The first seven, in order, are Bangladesh, Cambodia, Peru, Ecuador, Vietnam, Colombia and Mexico.

Grameen Bank and Muhammed Yunus won the Nobel peace prize for microfinance in 2006. The template was for poor women without collateral to form small groups where the borrowers guaranteed each other’s debts. Groups had weekly meetings which coincided with their payment of obligations. With very low default rates, microfinance grew tremendously as a way to help put food on the table for the poor.

Soon, however, a number of problems started to confront the program. Researchers discovered cases of borrowers resorting to selling other properties only to avoid delinquencies during the weekly meetings. Cases of over borrowing and mass defaults were reported in Andhra Pradesh of India, in Pakistan and in Nicaragua.  Pole vaulting (borrowing have been resorted to by some borrowers.

Researchers who conducted randomized controlled studies in several countries began to question the effects of micro lending in raising the economic fortunes of the poor. While the loans increased business starts for those without business to begin with, for those already in business the impact has not been encouraging. Although the loans did not necessarily create more jobs in the economy, at least it helped people to smooth shocks and manage the rudiments of basic survival.  It is not enough that the business model is profitable, have scale and is presumed to have impact because there is demand for loans and it is being repaid. The impact must be palpable,

A number of critics are also questioning the motivation of some microfinance institutions who label themselves social enterprises. Social enterprises must stay true to their mission, which means putting a level of constraint to the profitability they can achieve as well as being actually committed to the desired transformation in the lives of clients, on their ability to earn a stable income, have more consumption and generally live better.

Then there is a question of who to reach. Dean Karlan of Yale University has observed that “despite the rhetoric, microfinance traditionally is not reaching the poorest of the poor… Micro lenders or microfinance institutions are not willing to go that far downscale because the loan sizes and savings amounts get to be so small.”

The good news is that the new growth in micro lending seems to imply lessons are being learned and are being applied to make microfinance work better. Group guaranteed loans are now being complemented by individual microloans. Such individual microloans have been common in Latin America and are spreading in South Asia. It is a little bit more expensive but new technology such as mobile money and telephony is spurring  its growth. Mobile money is expanding the way data is gathered and the distribution of loans. Scoring models are being developed. And new product offerings like insurance and savings are being introduced. In Latin America, much micro-lending is funded by deposits. It is a slower process but it means financial inclusion is going beyond debt and is encouraging the development of a savings mindset among clients. A number of micro lending schemes are bundled with training and education. Some micro loans are in the form of business inputs and supplies.

Another change is the pacing of repayment terms outside of the weekly routine. Some loans are now paid on a monthly basis, for example, although it may also expose lenders to bigger repayment risks. This highlights the need for repayment terms that coincide with the business recovery cycle. There are also experiments to provide borrowers with grace period in order to allow the business to appropriately incubate and set-up. The problem with such flexible terms is whether the size of the loan justifies such leeway, and wil the flexibility not in fact encourage more loan defaults?

Micro lending and microfinance are not perfect solutions but cannot be overlooked in the war against poverty. What is important is to address its weaknesses and shortcomings and to move forward with solutions that will ensure that the impact to a bigger portion of participants will be positive by way of a better quality of life. At the end of the day, it is a business model whose potential deserves innovative intervention.



 

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