Role of microfinance in reduction of poverty

A program for supply of small loans to, and

mobilization of small savings from clients who do
not have access to formal financial markets.
The term was coined to describe the replication of
the Grameen Bank credit program in the
developing world.
It combines savings mobilization as a part of a
credit delivery system that supply of small amount
of loans (micro-credit) to low-income households
for generation of self-employment.
 A socioeconomic study of credit operation in a village near
Chittagong University ( Zobra) by Professor M. Yunus laid the
foundation of micro-credit model in 1976
 The study observed that many low-income households
operate tiny economic activities by taking loans from
moneylenders with very high rate of interest, often 10
percent per month.
 After paying the interest and the principal, the borrower has
very little surplus left to accumulate savings to expand
business.
 The operators are thus perpetually dependent on
moneylenders for high-interest loans that sustains the
vicious circle of poverty.
 If credit could be extended to these households on easy
terms, they could save small amounts at the end of each loan
cycle, increase equity in the business, and move on a ladder
for poverty reduction.
 But banks do not consider them credit-worthy since the size
of loan they demand is tiny, and they cannot offer any
collateral that could be invoked in case of default.
 Dr. Yunus went to a nearby branch of a Krishi Bank and
pleaded to give them loans under his own personal
guarantee.
 Since the borrowers are engaged in activities that generate
regular incomes (cottage industries, petty trade etc), he
developed a weekly loan repayment system that suits the
circumstances of low-income households.
 The loans were all repaid in time to the surprise of the bank
officials. But, they thought that the borrowers behaved well
because of the personal influence of the professor.
 The senior management of the Krishi Bank gave
him a challenge to replicate the experience in an
area outside Chittangong.
 A low-cost loan fund (obtained from a grant from
IFAD) was offered to Professor Yunus to operate his
credit program in Tangail district where he is
unknown to local people.
 With repeated experiments a loan delivery and
repayment system was developed appropriate to
the needs of poor people.
 The success of Chittagong was repeated in Tangail.
 In 1984, the Ministry of Finance was convinced of
the micro-credit model, and the Grammen Bank
was formally launched
 Formation of a five member group with like-
minded people to act as peer pressure to ensure
proper utilization of the loan and repayment in
time.
 A number of groups in the village was federated to
form a Village Organization called Centre which
meet once a week on fixed date and time.
 The Centre is used as a platform to conduct bank
business, and bring credit services to the
doorsteps of the people
 The credit was offered to households through
women members, as they are found more
responsible with money.
 Giving control over money could help empowering
women
 The weekly meetings was a venue to use credit as
an entry point for all round social development.
 Sixteen decisions to prevent social ills and good
healthcare, hygiene and nutrition become the code
of conduct for members of the credit program. The
weekly meeting used to begin with chanting the
sixteen decisions
 Members themselves propose economic activities
to be financed with the loan. The proposals are
scrutinized by the members in the weekly meeting
which are attended by a bank worker.
 The loans are disbursed in the meeting, weekly
repayments are collected, and social issues
affecting the lives of the members are discussed
 Loans are offered for a year with a schedule of repayment
with 50 equal weekly installments, and the repayment of
interest in the remaining two weeks.
 Two members of the Group are offered loans in small
amounts. Other members receive loans when the first two
members maintain the repayment schedule. The Group
becomes ineligible for a new loan if one member defaults.
 Five percent of the loan amount is deducted at the time
disbursement of each loan. The amount is deposited in a
savings fund along with the personal weekly savings.
 The Group Fund thus accumulated was maintained with the
Grameen Bank as savings for the Group. The accumulated
savings could only be withdrawn when the member leaves the
Group.
 An Emergency Fund was also instituted as an insurance
against loss of capital due to unforeseen circumstances.
 The Grameen Bank model was accepted by many NGOs in
Bangladesh engaged in empowering the poor through
community development.
 Some NGOs were established with sole purpose of providing
credit to the poor and making micro-credit as a self-
sustaining business, a model developed by ASA.
 The Palli Karma Sahayak Foundation (PKSF) was established by
the government (with support from the World Bank) to
encourage local NGOs support generation of self-
employment with micro-credit.
 Professor Yunus set up Grameen Trust to replicate the
Grameen Bank model internationally. The World Bank set up a
consortium Consultative Group for Alleviation of Poverty
(CGAP) to support this effort internationally.
 Since mobilization of savings was a part of the objectives of
micro-credit organizations, micro-credit was renamed as
microfinance by academic institutions.
 Unemployment and under-employment of the
labor force are root causes of poverty
 At low levels of income the size of the formal
sectors – manufacturing and services – is small.
Even a double digit growth rate cannot absorb all
additions to the labor force.
 Those who cannot find employment in the formal
sectors are absorbed in agriculture and informal
sectors, creating massive under-employment and
disguised employment
 Credit is a capital support. The unemployed worker
can combine capital with her/ his labor to produce
goods and services which can be sold in the
market.
 Access to credit can lead to gradual reduction in poverty if
the rate of return on capital in the self-employed enterprise is
higher than the rate of interest charged on the loan
 The speed of the process to poverty reduction depends on a)
the demand for goods and services produced with the loan,
b) the size of the loan, and c) the propensity to save the
additional income.
 The payment of weekly installments made it easy for the
borrower household to save the income from the loan. At the
end of the loan cycle, the loan becomes equity. With a repeat
loan the size of the capital grows.
 The larger the difference between the rate of return on
capital and the rate of interest charged on the loan, the faster
the income grows, and the household moves on the path of
virtuous circle of poverty reduction
 Microfinance is suitable for activities that generates regular
incomes, because installments have to be paid on a weekly
basis.
 Activities include rickshaw and van driving, small scale petty
trading, peddling, shop-keeping, poultry and dairy cow
raising, cottage industries such as rice husking and
handlooms operations, etc.
 Activities that generates income on a seasonal and annual
basis such as crop farming or beef fattening were not suitable
for organization with micro-credit, unless the household had
a side business that generates regular income from which the
installment can be paid.
 Many households became engaged in multiple enterprises to
suit micro-finance delivery system.
 If the credit is properly utilized in an activity that gives high
return on investment, recovery of loans is not a problem.
 Low opportunity cost of labor encouraged borrowers to
accept self-exploitation of labor as long as total income from
the enterprise is higher than the alternative wage earnings in
the market.
 Human capital intensive delivery system and the small size of
loan make microfinance a high-cost operation.
 The rate of interest charged on the loan must be high in order
to make the micro-finance organization self-sustaining.
 Coercion is used by bank workers to get repayment from
unsuccessful borrowers which led them further into poverty.
 Microfinance is no longer an entry point for social
development. With the ASA model to make Microfinance an
income earning business.
 The experience was a gradual de-emphasize on social
development activities that accompanied microfinance
movement in the early years.
 Microfinance has become a business with many financial institutions
interested in lending money to microfinance organization
 Microfinance business has expanded vastly reaching market
saturation. Over the last few years microfinance business has been
expanding at a rate of over 20 percent per year
 Grameen Bank, ASA and BRAC alone extends credit to nearly 18
million households. PKSF funds nearly 250 local NGOs that may
cover anther six t million households.
 Bangladesh has only 30 million households, 25 million in rural areas
where most of the microfinance business is conducted.
 Studies from household side however shows that not more than 50
percent households have been reached with credit services.
 Overlapping has become a big problem. One household or different
members of the same household are served by a number of
microfinance organizations with adverse impact on credit discipline
and loan recovery.
 Over supply of credit and too much competition among
microfinance borrowers have led reduction in the rate of return on
credit, leading to difficulty in maintaining repayment schedule.
 Frequent natural disasters leading to loss of capital and disruption
of economic activity exacerbate the problem of maintaining
repayment schedule.
 Coercion on getting the repayment in time has created a negative
image for microfinance among the civil society in Bangladesh.
 Older microfinance organization have established better competitive
edge in the market due to accumulation of savings which is now
used as a low cost loan fund. For Grameen Bank the accumulation in
savings fund now exceeds the outstanding loan with the borrowers
 Many older microfinance organizations with high accumulated
savings now allow savings to be used to pay regular repayment of
installments to show excellent recovery on paper.
 We must recognize that traditional microfinance products (annual
loans with weekly repayments) has reached market saturation.
Further expansion will lead borrowers to poverty deepening than to
poverty reduction.
 The microfinance organizations must seek vertical expansion with
larger loan size with different loan products, and different delivery
and recovery mechanism
 It is not necessary to cover all landless households with micro-
credit. The expansion of micro-credit for generation of self-
employment in non-farm activities has led to tightness in the rural
labor market and rapid increase in rural wages. The micro-credit
movement thus has indirectly helped increase income for labor
selling households not reached by micro-credit
 There is unmet demand for credit for many other economic activities
in rural areas. These include crop farming, beef fattening,
acquisition of agricultural machinery, financing land leasing, and
financing cost of international migration etc.
 Traditional micro-credit model of delivery and recovery of loan
within a year is not suitable for servicing these loan demands.
Thinking “out of box” is necessary to extend supply of credit to
these directions.