Definition : Microfinance is the provision of financial services to low income clients who traditionally lack access to banking and related services.
Objective : of this blog post is to understand in very simple terms how the Microfinance industry has changed over the years and the way forward.
The Paradigm Shift : The Microfinance industry, after a relatively low key existence for many decades, has started attracting limelight, for reasons both right and wrong. This is how the paradigm is shifting.
|Are the poor risky to lend?||This bottom of the pyramid segment was considered too risky to lend, keeping banks and prominent financial institutions away.||With the established Microfinance Institutions (MFIs) earning profits, converting into banks and going public, bigger banks and mainstream financial institutions are getting attracted and are directly getting involved.|
|Commercialization||Microfinance was a relative cottage industry championed by antipoverty and development activists||Big banks, private-equity firms and pension funds are pouring in billions of dollars, resulting in the industry growing by 30%-40%. Banks are convinced there is money to be made.|
|Sophistication||Limited sophistication, limiting the reach||Millions are being reached with increasing sophistication and use of technology|
|Competition||Limited competition, but that ensured stability of employees and adhering to processes.||Intense competition. Disadvantages
|Social Service or Profiteering?||MFIs for social service that could ameliorate poverty and yet earn profit.||Profit is a prerequisite to ensure returns to the shareholders/investors who are pouring in the billions.|
|Reach||Less availability of funds meant reaching less number of poor||With the MFIs slush with funds, reaching large number of poor is not a problem|
|Interest rates||MFIs could easily charge up to 36% in India (on the pretext of high cost of funds – 15% and other costs), and even higher in some African countries.||With spotlight on MFIs, there is little possibility of a high interest rate regime prevailing. For example, in India, the MFIs are already reducing interest rates by 2%!|
|Purpose of Microfinance||Capital for entrepreneurs||Capital for entrepreneurs as well as for purchase of consumer durables and for fulfilling other personal needs.|
|Recovery of bad loans||Seldom controversial||Reckless lending has resulted in default. Couple of suicide cases amidst accusations of forced recovery has made the matter politically sensitive.|
Here is one of the video reports that has brought spotlight on the Microfinance industry in India for the wrong reasons.
At Crossroads : Clearly, Microfinance is undergoing a revolution, and the players in the industry as well as governments have a role to play to take full advantage of it instead of taking the wrong turn! Here is what the industry and the governments should do!
- Lending should be strictly in the form of credit for entrepreneurs instead of being a consumer durable loan or a personal loan. That’s risky and defeats the purpose!
- Governments should act as a facilitator and a watchdog, rather than being a player themselves (The Andhra Pradesh government in India is trying to be a player, which is uncalled for!). No politics please!
- An upper limit on interest rates that can be charged from the poor (ceiling) should be determined by the central banks to avoid exploitation/profiteering. Only those institutions will then remain in the fray who intend to provide a social service that also earns money (and not the other way round!)
- Reckless lending and/or multiple loans to the same family under competitive pressure should be avoided by MFIs. That’s a recipe for disaster.
- Recovery agents should be regulated. They may employ illegal means for recovery without the knowledge of the management.
If the above points are adhered to, many of the ills that plague the industry today can be removed.
- The Big Trouble In Small Loans http://www.time.com/time/magazine/article/0,9171,1812051-1,00.html
- Wikipedia Microfinance http://en.wikipedia.org/wiki/Microfinance
- Milking the cow for what it’s worth http://indiamicrofinance.com/analysis-ap-microfinance.html
- Killing microfinance will help moneylenders http://blogs.timesofindia.indiatimes.com/Swaminomics/entry/killing-microfinance-will-help-moneylenders
- Indian microlenders offer debt restructuring http://www.ft.com/cms/s/0/af647c48-df39-11df-bed9-00144feabdc0.html?ftcamp=rss
- The real revolution in microfinance http://blogs.reuters.com/barbarakiviat/2010/10/22/the-real-revolution-in-microfinance/
What are your views on the direction Microfinance is taking? What steps need to be taken to maximize the benefits of the revolution that is sweeping the MFIs? Your views are welcome!