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Microfinance for Combating Poverty

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What is microfinance? according to the Jonathan Morduch microfinance stands as one of the most promising and cost effective tools in the fight against global poverty. Microfinance refers to the provision of very modest loans (microcredit) which is free of collaterals to very poor families in order to assist them in engaging in productive income generating activities or developing their small companies. For examples of micro-enterprises including basket-making, sewing, street vending, raising poultry etc. This is not a new concept, nor is regulation and oversight of microfinance institution (MFIs). Every industrialized country and certain developing countries, particularly in Asia have a long history of microfinance.

Microfinance institution (MFI) today refers to a wide range of organizations dedicated to delivering these services, such as NGOs, credit unions, cooperatives, private commercial banks and parts of state-owned banks and non-bank financial institutions.

The Grameen Bank

When talking over microcredit and microfinance, the Grameen bank story is a good point to start. The Grameen bank model is known globally as the “grassroots” of micro financial models. In 2006, the Grameen bank and its creator, Muhammad Yunus, received the Nobel Peace Prize for their efforts to alleviate poverty in Bangladesh and this model was founded in early 1970s.

Since 1976, when he first lent $27 to 42 stool makers, Yunus has grown this Grameen bank to include more than 5.5 million members and more than $5.2 billion in disbursed loans. Mainly the Grameen bank aims the poor with the primary goal of lending to women and it now has more than 95 percent of women over 5.5 million members. Further, the original Grameen bank was one of the first MFIs that incorporated a compulsory savings requirement into their lending structure. Every client was required to make a deposit worth 5 percent of their given loan, which was placed into a group fund with strict withdrawal rules (generally no withdrawals before three years).

Lending to poor villagers causes a substantial credit risk as the poor are thought to be uncreditworthy, that is they lack the skills or expertise required to put borrowed funds to best use. But the Grameen bank has challenged decades of conventional wisdom about lending to the poor. Its success has clearly verified in two ways. First, it has demonstrated that poor households can benefit from increased credit availability and that credit provision can be an effective tool for poverty alleviation. Second, it has demonstrated that institutions do not always experience significant losses when lending to the poor.

Microfinance has spread to five continents and many countries since the Grameen bank’s initiation. Bolivia, Chile, China, Ethiopia, Honduras, India, Malaysia, Mali, the Philippines, Sri Lanka, Tanzania, Thailand, the United States, and Vietnam have all replicated the Grameen bank. Majority of microfinance operations occur in developing nations.

Microfinance in Europe and Asia

Microfinance is developed from informal beginnings as a type of banking of the poor in numerous European countries during the eighteenth and nineteenth centuries as well, in contrast to the commercial and private banking sectors and the history of microfinance in Europe shows that local financial organizations can progress from very modest informal beginnings to semiformal finance where networking and self-regulation are important and then to mainstreaming as a key component of the banking sector.

Concerning the microfinance in Ireland and Germany as European countries, microfinance in Ireland spans the years 1720 to 1950 and has nothing to do with modern moves to establish credit unions. It is the story of how self-help led to financial innovation, how legal support and favorable regulation established a widespread microfinance movement, and how commercial banking interests brought it down. The story of microfinance in Germany has been one of self-help, regulation, and supervision, which has resulted in the largest microfinance industry of any country in terms of population. It is made up of two networks: community savings funds, often known as savings banks and member-owned cooperative associations, sometimes known as cooperative banks.

In Asia microfinance is apparently much older, though little is known about the early history of the hui in China, chit funds in India, arisen in Indonesia, paluwagan in the Philippines to name a few.

The case of India demonstrates that the origins of microfinance precede those reported above in Ireland and Germany by two, if not three millennia. In India, at least three strands of indigenous finance have a long and complicated history: moneylenders, chit funds or rotating savings and credit associations (ROSCAs) and merchant bankers – much of it yet to be schematized and all still in existence today. However, in India, several types of microfinances can be categorized such as, joint liability group, self-help group, Grameen bank model and rural cooperatives while the Grameen bank model has not been completely implemented since rural credit and recovery systems are a major issues and rural cooperatives served only credit-worthy persons in rural regions.

India faced an underdeveloped rural economy, high levels of indebtedness and a lack of effective financial services when it gained independence. Since the 1950s, a lack of access to credit to finance production assets has been responsible for a lack of rural development.  Private Banks which should have provided such credit were not present in rural regions and informal finance provided by moneylenders, friends, relatives and rotating chit funds was insufficient.    

The history of microfinance has yet to be written in the majority of poor countries. Many will find it difficult to do so due to a lack of written documents. This makes it difficult to build on the existing, primarily informal, microfinance foundations and learn from previous experience

For example, Nigeria is the only African country south of the Sahara where microfinance existing at least 500 years ago, in the form of rotating savings which believing that it is acquired from Indian rotating chit funds method and credit associations. In Nigeria, they are known as “esusu” by the Yoruba and are now a lingua franca term in many West African countries. Nigeria is one of the countries with a high prevalence of informal financial institutions and informal microfinance remains the most prominent form of microfinance.

Benefits of microfinance

Poor families are often excluded from the official banking system due to a lack of collateral, but the microfinance movement takes advantage of novel contractual structures and organizational forms that lower the risk and cost of providing modest, uncollateralized loans. Therefore, microfinance enables people especially poor people to invest in their small enterprises and then can access to credit, assistance with education, encourage them to save money, create chances for employment and provide micro insurance; insurance products can offset the cost of medical care as well.

However, the microfinance developed as a noble solution for informal credit and is regarded as a powerful tool for poverty alleviation among economically active but financially limited people. Therefore, microfinance is a strategy used to improve the quality of life of those who do not have access to long-term funding. With more transparency from institutions and improved rating criteria, the inflow of investment funds from foreign markets will continue to drive microfinance toward a poverty-free world.

Nisanshani Chanchala Thilakarathne, BSc (Agri)

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