Microfinance and Its Challenges

I thought I would take a little bit of time to go over concepts related to the field of microfinance.

What is Microfinance?

Microfinance is a global initiative to provide financial services to low-income clients who lack access to basic banking and related services. Microfinance institutions target the poor and near-poor families by granting very small loans to borrowers, taking little or no collateral. Some common microfinance practices are:

• providing group lending and liability
• establishing mandatory savings requirements
• increasing loan sizes once existing loans are repaid fully and on time and implicitly guaranteeing access to new loans

In summary, microfinance movement aims to provide the poor, including those who lack credit history, with permanent access to financial services ranging from credit and savings to insurance and transfers.

Difference between Microcredit and Microfinance?
Microcredit describes small loans made to borrowers (often unsalaried) with little or no collateral.
Microfinance is a term that includes microcredit, savings, insurance, and other financial products.

Who are these borrowers?
Typical borrowers are poor and often lack a dependable sources of income. As a result, they have no credit or assets that can be used to gain access to banking systems. These individuals are usually self-employeed and work and live at their homes.

Also they generate income through operating small shops, street vending, crafts store in urban areas. For those who are out in the rural areas, most live by farming.

What are the benefits of Microfinance?
Access to credit helps the poor to allocate capital for dry times when access to essentials like food, clothing, shelter, even water is lost. In addition, when emergencies take place, credit can enable the borrower to manage events like sickness or natural disasters. Finally I have witnessed firsthand that women are empowered and gain rights like ability to manage finances that were once denied.

Why are the microfinance interests rates not lower?
This is due to the fact that the total cost associated with making small loans are much higher than large loans. The time it takes to complete 100 small loans versus 100 large loans may be the same except the profits are much smaller for small loans. Also, loans are considered higher risk since borrowers frequently lack credit history. The distribution of funds may be difficult if the borrowers live in rural or remote areas. I have also taken bodas out to rural villages that may only be accessible by walking or bodas.

Do savings services also help people?
Microfinance as mentioned above includes savings as one of its offerings. Without savings, the poor will hide cash in mattresses or holes or purchase jewelry or valuables that can be sold later. Two huge drawbacks exist - the goods substituted for cash are illiquid and stockpiled goods (including cash) are at risk of theft, depreciation, or accidents. Savings services offer reliability and convenience.

Challenges

I am beginning to discover that there are still many lessons left to be learned and obstacles to overcome.

Here is a list (non comprehensive of course) of challenges that practictioners of microfinance face today.

• Some institutions seek to gain profits through confiscation and selling of collateral when the loans become deliquent.
• Many organizations lack tools and know-how to assess viability of potential loans
• Borrowers pay kickbacks to loan officers for expediting and approving loans.
• Organizations approve loans without providing resources or technical expertise to the borrowers.
• Individuals are unaware of the terms and conditions of the loans because they are semi-literate or the loan officers fail to share information. Access to information is asymmetric. This means people often take out loans without understanding the short and long term implications.
• Borrowers often live in remote areas so that they need to travel far to make payments or savings. Especially in Ugandan towns, farmers simply do not save because they may spend up to 50% of their intended savings on transportation.
• In many markets, there are multiple microfinance organizations that compete for the same borrowers. As a result of this market concentration, the borrowers take out multiple loans, often to service existing loans. This diminishes incentives to pay and weaken the risk-mitigating effects of small loans.
• Due to the explosive growth of microfinance institutions, staff and employees were often added to the organization without providing extensive training. As a result, many systems and controls in these microfinance organizations no longer function properly as safeguards to abuses and malpractices. Here's a quote from the field,"Any organization that grows beyond its supervisory capacity can end up facing high defaults."
• Many smaller institutions solely rely on paper work and processes are manual. Without automation, manual entry decreases efficiency and severely hinder efforts to improve accurate reporting and transparency.

In conclusion, if you are willing and able, microfinance is a field that will offer plenty of challenges and problems to solve... Next blog will cover the potential solutions.