Microfinance: The Caviar And Caveats To Poverty Alleviation

Let's tell it like it is. What's the big fuss about microfinance? Is it all that it’s made out to be?

Imagine living on a farm in a developing country.

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You make less than $1 a day with hard physical labor. You struggle with buying basic necessities for yourself, let alone your family. You're tired, you feel stuck, and you want to escape.

One year, you use a unique farming technique you learned from a neighbor, and your harvest that year is incredible. You want to sell most of the crops before they rot. To your dismay, the nearest market is miles away. You will definitely need a donkey to haul the crops, and cattle is expensive. How are you supposed to afford a donkey to seize this profitable opportunity?

Above is a particular and imaginary example, but it is not far from the realities of many. According to the UN, "About 20 percent of the world's population, 1.2 billion people, live on less than $1 a day." Poverty is a global issue, and people who suffer from it are often trapped. Fortunately, microfinance can help.

In a nutshell, microfinance is financial services offered to the poor.

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The purpose of microfinance is to alleviate poverty for its clients. People with no income can now have access to capital and services that will improve their situations. Thanks to microfinance, you can get a loan from the local provider to buy your donkey, sell your crops, and pay back your debt later. You will have made a profit by then so you can buy better seeds or even another donkey!

At the same time, the lender institution makes money off of your interest payments. Then, with its profits, it can extend the same services to others in your shoes. Voila! Everyone will be able to afford a donkey eventually! Isn’t microfinance amazing?

Microfinance was brought to life by Dr. Muhammad Yunus, a professor from the University of Chittagong in Bangladesh.

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In the 70's, Dr. Yunus, the beaming man pictured above, visited a village called Jabra in Bangladesh and met a group of 42 women who couldn’t repay their loans. He allegedly lent the group $27, and that was enough for the group to escape their debts. After seeing how much $27 did for these women, Dr. Yunus fathered the Grameen Bank to provide financial services to the region. The term microfinance thus originated. The “micro” prefix can be derived from the small amounts of money (relative to advanced economies, of course) that is usually lent out to clients.

The current score is as follows: Dr. Yunus: 1; Crippling Debt: 0.

Microfinance has evolved since the early days in Jabra and has made a dent in global poverty reduction.

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Today, microfinance institutions are offering more than just loans. They are providing comprehensive services such as insurance, deposits, and financial education. Impact wise, contributed by microfinance, the Global Findex Database by the World Bank stated that “62 percent of adults worldwide have an account at a bank or another type of financial institution or with a mobile money provider” in 2014. A report by a German investment firm responsAbility estimated that about 700 million people obtained savings accounts between 2011 and 2015. It'd be fair to admit that those numbers are...

A reason why there is so much activity in microfinance is because this business can actually make it rain.

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There has been a reported yield of 27.4% on credit portfolios among 1,319 microfinance institutions in 2013. For investors, this means earning a return of 27 cents for every dollar put in. Not only can microfinance be beneficial for its target clients, it can also be good for companies and the wallets of investors. Additionally, microfinance improves the overall economy. What could be better than that? In Australia, every dollar loaned created $1.22 worth of return in the economy. For all players, microfinance seems like a winning game. Applause for microfinance!

While it is true that microfinance has positive impacts, it can actually be a double-edged sword.

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The key factor of any debt is the interest rate, and microfinance loans are no exception. Often, these loans carry hefty interest rates that drive up the amount of repayment that the customers must make. A microfinance bank in Mexico, Banco Compartamos, has lent out money with triple digit interest rates. Such high interest burden can put families further into debt, basically ridding their chances of escaping poverty. Who can they turn to next? What is even the point of using microfinance in the first place?

To prevent microfinance institutions from exploiting people, the government can step in. However, an incompetent government can cause further problems.

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A ban on microfinance was instituted in Andhra Pradesh, a state in India, in 2010. The results were disastrous: average household consumption dropped 14 to 15 percent, and $1.2 billion worth of loans were defaulted. Such drastic government measure actually damaged the local economy.

Government can also limit the amount of money that a microfinance provider can lend out, known as a loan ceiling. Seemingly a good idea, it actually may not work. A high ceiling is pointless. A low ceiling can increase the cost of lending (higher transaction costs), which negatively affects the institutions, and thus its customers. Point being, if the government isn’t smart about regulating microfinance, it can harm its citizens indirectly.

Microfinance is not a scarf: one-size-fits-all approaches don't always work.

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In some cultures, social hurdles make microfinance services less effective. A prominent example is Pakistan, where women are discouraged from obtaining credit because of their social role in the country. This is just the truth and our hands are tied, but that's a tale for another day. Women and other minority groups can be put between a rock and hard place if they are presented with these opportunities. It would be hard to say no, yet few may say yes.

Also, some societies have their way of “providing” financial services. In Cambodia, when people need money, some may take the risk and take out loans from loan sharks; below is a visual representation of a menacing loan shark. These informal ways of lending are usually the established way of doing things, and it may be difficult for microfinance to compete. Why would you complicate your life more than it already is? It might actually be harder to go through a microfinance provider to get legal capital because of tradition.

The key is good intentions and smart government regulations.

In microfinance, the goal to help the poor and the goal to make money are in conflict with each other. Institutions make money off of their clients by collecting interest and fees, but they must also help people; kind of counterintuitive. The dilemma is to do both. Companies must make money to stay in business, but they can't forget why they entered this business in the first place. Keeping their intentions constant is important to make sure that they are not exploiting their clients.

It is also important to craft policies that protect customers and promote microfinance's growth. A country must ensure that its citizens have sustainable access to financial services regardless of income. That country must also keep microfinance in its borders to help its citizens. Moreover, because all countries' conditions are different, the government has to be mindful of all intricacies before making any major legislation. As always, with great power comes great responsibility.

Basically, microfinance is great, but it has its caveats.

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The theme here is balance (Namaste). We have to remember that poverty alleviation, not company profits, is the most important point of this whole conversation. The future of microfinance is dependent on the intentions of all players involved. If you’re ever considering going into this field, please remember to advocate for those in need!

Can we get a heck yeah for poverty alleviation?!