Since traditionally the poor of the world haven’t had access to credit and other financial services, they have had to rely on informal methods to save and borrow. “Collateral-free lending, proximity, timely delivery and flexibility in loan transactions are some of the attractive features of the informal credit system. In such a situation, formal credit still remains elusive for the rural poor.” (Vatta 432) Vonderlack and Schreiner list the following methods utilized. First, there are door-to-door collectors who come to their client’s doors daily to collect how much the client desires to save and then at the end of the month they give it all back to the client minus their fee, which for example could be two days worth of savings. The drawbacks to this method are that the money may not be safe and the client’s funds are not anonymous. Annual Savings Clubs and Rotating Savings and Credit Associations (RoSCAs) are both groups of people who all contribute to a fund on a monthly basis and the person who gets the total of the contributions rotates month to month, or on some scheduled basis. Members can also borrow against the value contributed. In Sub-Saharan Africa these groups are called esusu. Safety of investment and anonymity are the major downsides to these two types of savings groups. Finally, individuals may purchase small valuables that can easily be hidden and/or easily exchanged for their value. The danger of this method is that individuals may not get the full value out of their item or they may be stolen. “Despite its exploitative nature, informal lenders still continue to occupy a considerable share of the rural credit market.” (Vatta 432)
The major advantages to all of these informal systems are that they are low transactional costs for the saver/borrower and the potential to access fund quickly. “Thus it may be useful to combine the strengths of the informal mechanisms (low transaction costs and assistance with saving discipline) with those of the formal mechanisms (safety, positive returns, quick access to funds and anonymity).” (Vonderlack and Schreiner 606)
The original and most prevalent form of micro-finance is micro-lending. Micro-lending or micro-credit is small-scale loans granted to individuals or to small groups in order to begin or grow an economic enterprise. This trend has emerged as a way to target individuals living in poverty who either have no credit history or would not be deemed credit worthy by major banking institutions. “Perpetual poverty and lack of adequate credit have remained the major constraints in the economic upliftment of rural household. Credit promotes capital investment and adoption of new technology, leading ultimately to better standards of life due to increased production and incomes.” (Vatta 432) Access to credit can help develop rural areas, eliminate poverty and reduce dependence on informal moneylenders.
Vatta argues that micro-credit can be a better mechanism to reduce poverty gradually and consistently. Vatta claims, “The provision of even very little credit helps the poor to improve their income levels. Small amounts of loan, coupled with financial discipline, ensure that loans are given more frequently and hence credit needs for a variety of purposed and at short time intervals can be met.” (Vatta 432) Drakakis-Smith claims that many food stand operators in Harare, Zimbabwe, “…were anxious to become a more permanent part of the retail scene but they lacked capital and the opportunity to become permanent stall holders.” (Drakakis-Smith 18) If those food vendors had access to micro-credit, they could expand their business in the marketplace and (1) provide more food access to those who needed it, (2) improve their own economic standing and (3) stimulate the economy.
Micro-finance in Bangladesh: A case study
Khandker conducted a case study in Bangladesh to evaluate how micro financing could increase household savings as well as reduce dependency on informal lenders. Khandker used data collected by the Bangladesh Institute of Development Students and the World Bank in 1991 and 1992. Here are some excerpts from their findings.
“With an easy access to a microfinance program, the poor save regularly to build financial and physical capital.” (Khandker 49)
“In Bangladesh, microfinance accounts for more than half of rural and financial transactions and reached about 30% of rural households in Bangladesh.” (Khandker 49)
“In particular, we find that having a facility in villages encourages households to save more- the presence of a programme increases the proportion of households who save from 17% to almost 60%.” (Khandker 75)
“Results show that a 10% increase in borrowing [by men or women] increases savings by 6%.” (Khandker 76)
“Results indicate that micro-borrowing increases not only the mandatory savings among the poor but also their voluntary savings.” (Khandker 50)
Khandker concluded that there was a clear improvement in savings for the poor who participated in micro-lending programs.
While micro-credit has been the most traditional application of micro-financing, savings assistance is emerging as another service to provide. “Although not all people are credit-worthy or want debt, all people are deposit-worthy and want assets.” (Vonderlack and Schreiner 603) “…small loans are not always appropriate for poor women. After all, a loan becomes debt and the poor are exposed to crisis if expected sources of funds for repayment evaporate.” (Vonderlack and Schreiner 603) The repayment of a loan could be a drain on incoming capital for a low-income household and prevent economic growth. “A wealth of evidence now suggests that many ostensible micro-enterprise loans are in fact used for consumption and are repaid out of existing income sources. Thus, the poor have a strong demand not just for micro-enterprise loans, but also for financial services that help them manage liquidity in the household.” (Vonderlack and Schreiner 603)
Khandker found in his case study in Bangladesh that as savings increased in the poor, micro-credit loan repayment increased by 40%. This indicates that self-sustainability could be greatly improved for the MFI if they created savings programs to complement credit programs. (Khandker 76)
Vonderlack and Schreiner propose a variety of savings assistance methods. The first is educational programs connected to savings. This would require the client to enroll in education courses and upon completion, would receive a match of savings amount or similar contribution. A second idea she proposes is the idea of a savings club. This club would unite together a small group of women who would work to save together. Each woman would have control over their own money, but if each member abided by certain standards, they would all be eligible for a bonus. Example of requirements could include a certain number of consecutive deposits or minimum deposit amounts. They would not be a punishment for not achieving those requirements, but they wouldn’t receive the bonus. (Vonderlack and Schreiner 610) In a program like matched savings, donors (such as NGOs) or government grants would match small-scale deposits to savings accounts. (Vonderlack and Schreiner 610) She outlines two programs specifically for women to include safe-deposit boxes and matched savings accounts with the added feature of matched withdrawals when events such as childbirth or the start of a school year occur. (Vonderlack 610)
Benefits and Drawbacks
Karmakar names empowerment as the major benefit to the savings assistance and micro-lending to the poor. He states that those benefiting from these services end up spending more on education, which leads to better attendance and lower dropout rates. Women specifically benefit from access to financial services and are able to contribute more to the household income. Household and maternal health improves as nutritional intake improves and therefore individuals are able to combat illness better. Furthermore, there is a reduced dependency on informal and other non-institutional lenders who operate in the rural areas. (Karmakar 23) Finally, smaller scale funding can be run without reliance or dependency on foreign intervention or funding. In discussing the micro-finance model initiated in India Karmakar states, “…the model has clearly emerged as the primary model for providing rural microfinance services as a proven method of extending formal financial services to the un-banked rural clientele. This is a home grown model, very flexible and without any dependence on foreign funding.” (Karmakar 22)
In spite of all the advantages of micro-financing, there are some areas of weaknesses. “The interest rates charged by MFIs (micro-financing institutions) are a matter of concern. It has been noted that MFIs chare high rates of interest to attain sustainability and pass on the higher cost of credit to their clients.” (Karmakar 24) The high interest rates are reflective of the fact that the institutions access to capital is limited and they rely on a high return rate from their clients in order to be sustainable. Another reason why interest rates are so high is to offset the cost of transaction for the small loan amount. Karmakar argues that MFIs need to, “Develop strategies for increasing the range and volume of their financial services to attain sustainability while charging reasonable rate s of interest to cover costs and risks.” (Karmakar 24)
Khandker argues that savings should be a necessary aspect of all micro-credit loans. The savings of clients can be used to fund other loans and increase self-sustainability of the programs. He contends that due to the funding from donors or grants that microfinance programs don’t need to rely on savings collected to support lending activities. Therefore, they often times don’t develop this sector of services. (Khandker 50) Khandker argues this is a mistake. “For the self-sustainability of the lending programmme of a microfinance institution, increasing reliance on deposit and savings mobilization is a necessity. Savings can be a relatively inexpensive source of capital for re-lending. Small amounts of savings can also be a great source of strengths of the poor households in smoothing consumption and building assets as collateral. “ (Khandker 52)
Another criticism of micro-financing is that the “poorest of the poor” have not been able to benefit from these financial options. “CGAP’s (Consultative Group to Assist the Poor [and NGO]) guidelines for best practices are based on the belief that: financial services should include credit, savings, transfers, payments and insurance; microfinance requires a sustainable, financial system approach to reach large number of poor people and micro-credit cannot always reach the poorest.” (O’Brien 108) However, this criticism could easily be remedied by expanding existing successful programs. It is, in part, a problem of too much demand and not enough supply.
Karmakar articulates the following guidelines in an effort to make microfinance programs a more mainstream service with consistent expectations. They include, “ (a) opening of saving bank accounts in the name of SHGS (self-help groups, small groups applying for loans as a unit), (b) SHG lending to be a normal lending activity of banks, (c) SHG lending by banks to be part of priority sector lending, (d) relaxation of margin and security norms for financing SHGS and (e) adoption of simplified loan documentation by banks for SHGS.” (Karmakar 22)
A final problem regarding micro-financing is and how to make micro-credit available for “non-farm economic activities.” “[A] major problem is finding an economic activity that will yield a rate of profit necessary to cover the interest rate on the loan and marketing of the product.” (Vatta 433) What other services or activities can be financed and initiated by those living in poverty? This is an area to be explored in order to offer further development.
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Africa, Asia and Haiti
All of the above