Microfinance

What is Micro finance.

“Microcredit, or microfinance, is banking the unbankables, bringing credit, savings and other essential financial services within the reach of.millions of people who are too poor to be served by regular banks, in most cases because they are unable to offer sufficient collateral. In general, banks are for people with money, not for people without.” (Gert van Maanen, Microcredit: Sound Business or Development Instrument, Oikocredit , 2004)

“(Microcredit) is based on the premise that the poor have skills which remain unutilized or underutilized. It is definitely not the lack of skills which make poor people poor….charity is not the answer to poverty. It only helps poverty to continue. It creates dependency and takes away the individual’s initiative to break through the wall of poverty. Unleashing of energy and creativity in each human being is the answer to poverty.” (Muhammad Yunus, Expanding Microcredit Outreach to Reach the Millennium Development Goals, International Seminar on Attacking Poverty with Microcredit, Dhaka, Bangladesh, January, 2003)

Microcredit belongs to the group of financial service innovations under the term of microfinance, other services according to microfinance is microsavings, money transfer vehicles and microinsurance. Microcredit is a innovation for the developing countries. Microcredit is a service for poor people that are unemployed, entrepreneurs or farmes who are not bankable. The reason why they are not bankable is the lack of collateral, steady employment, income and a verifiable credithistory, because of this reasons they can´t even meet the minimal qualifications for a ordinary credit. By helping people with microcredits it gives them more available choiches and opportunities with a reduced risk. It has successfully enabled poor people to start their own business generating or sustain an income and often begin to build up wealth and exit poverty. The amount of money that´s lended out seldom exceeds 100USD.

Microcredit fits best to those with entrepreneurial capability and possibility. This translates to those poor who work in growing economies, and who can undertake activities that generate weekly stable incomes. For those who don´t qualify because they are extreme poor like destitute and homeless almost every microcredit institution have special safety programs that offer basic subsistence and later endeavours to graduate this members in their microfinance program making ordinary microcredits available.

Microcredit plays an important role in fighting the multi-dimensional aspects of poverty. Microfinance increases household income, which leads to attendant benefits such as increased food security, the building of assets, and an increased likelihood of educating one’s children. Microfinance is also a means for self-empowerment. It enables the poor to make changes when they increase income, become businessowners and reduce their vulnerability to external shocks like illness, weather and more.

Microcredit has widely been directed by the non-profit sector while commercial lenders require more conventional forms of collateral before making loans to microfinance institutions. But now it´s successfully growing bigger and getting more credibility in the traditional financeworld. Due to that the traditional banking industry have begun to realize that this borrowers fits more correctly in a category called prebankable. T he industry has realized that those who lack access to traditional formal financial institutions actually require and desire a variety of financial products. Nowadays the mainstream finance industry is counting the microcreditprojects as a source of growth. Before almost everyone where neglecting the success of microcredit in the beginning of the 1970s when pilot projects such as ACCION where released until the United Nations declared 2005 the International Year of Microcredit.

The most of the microcredit institutions and agencies allover the world focuses on women in developing countries. Observations and experience shows that women are a small credit risk, repaying their loans and tend more often to benefit the hole family. In another aspect it´s also seeing as a method giving the women more status in a socialeconomic way and changing the current conservative relationship between gender and class when women are able to provide income to the household. Women are in most cases responsible for children, and in poor conditions it results in physical and social underdevelopment of their children. 1.2 billion people are living on less than a dollar a day. There are many reasons why women have become the primary target of microfinance services. A recent World Bank report confirms that societies that discriminate on the basis of gender pay the cost of greater poverty, slower economic growth, weaker governance, and a lower living standard for all people. At a macro level, it is because 70 percent of the world’s poor are women. Women have a higher unemployment rate than men in virtually every country and make up the majority of the informal sector of most economies. They constitute the bulk of those who need microfinance services.

Giving women access to microcredit loans therefore generates a multiplier effect that increases the impact of a microfinance institution’s activities, benefiting multiple generations.

History of Micro finance

The history of microfinancing can be traced back as long to the middle of the 1800s when the theorist Lysander Spooner was writing over the benefits from small credits to entrepreneurs and farmers as a way getting the people out of poverty. But it was at the end of World War II with the Marshall plan the concept had an big impact.

The today use of the expression microfinancing has it roots in the 1970s when organizations, such as Grameen Bank of Bangladesh with the microfinance pioneer Mohammad Yunus, where starting and shaping the modern industry of microfinancing. Another pioneer in this sector is Akhtar Hameed Khan. At that time a new wave of microfinance initiatives introduced many new innovations into the sector. Many pioneering enterprises began experimenting with loaning to the underserved people. The main reason why microfinance is dated to the 1970s is that the programs could show that people can be relied on to repay their loans and that it´s possible to provide financial services to poor people through marketbased enterprises without subsidy. Shorebank was the first microfinance and community development bank founded 1974 in Chicago .

An economical historian at Yale named Timothy Guinnane has been doing some research on Friedrich Wilhelm Raiffeisen´s village bank movement in Germany which started in 1864 an by the year 1901 the bank had reached 2million rural farmers. Timothy Guinnane means that already then it was proved that microcredit could pass the two tests concerning peoples paybackmoral and the possibility to provide the financial service to poor people.

Another organization, The caisse populaire movement grounded by Alphone and Dorimène Desjardins in Quebec , was also concerned about the poverty, and passed those two tests. Between 1900 to 1906 when they founded the first caisse, they passed a law governing them in the Quebec assembly , they risked their private assets and must have been very sure about the idea about microcredit.

Today the World Bank estimates that more than 16 million people are served by some 7000 microfinance institutions all over the world. CGAP experts means that about 500 million families benefits from these small loans making new business possible. In a gathering at a Microcredit Summit in Washington DC the goal was reaching 100 million of the world´s poorest people by credits from the world leaders and major financial institutions.

The year 2005 was proclaimed as the International year of Microcredit by The Economic and Social Council of the United Nations in a call for the financial and building sector to “fuel” the strong entrepreneurial spirit of the poor people around the world.

The International year of Microcredit consists of five goals:

• Assess and promote the contribution of microfinance to the MFIs

• Make microfinance more visible for public awareness und understanding as a very important part of the development situation

• The promotion should be inclusive the financial sector

• Make a supporting system for sustainable access to financial services

• Support strategic partnerships by encouraging new partnerships and innovation to build and expand the outreach and success of microfinance for all

The economics professor Mohammad Yunus and the founder of Grameen Bank were awarded the Nobel Prize 2006 for his efforts. The press release from nobelprize.org states:

“The Norwegian Nobel Committee has decided to award the Nobel Peace Prize for 2006, divided into two equal parts, to Muhammad Yunus and Grameen Bank for their efforts to create economic and social development from below. Lasting peace can not be achieved unless large population groups find ways in which to break out of poverty. Micro-credit is one such means. Development from below also serves to advance democracy and human rights. Muhammad Yunus has shown himself to be a leader who has managed to translate visions into practical action for the benefit of millions of people, not only in Bangladesh , but also in many other countries. Loans to poor people without any financial security had appeared to be an impossible idea. From modest beginnings three decades ago, Yunus has, first and foremost through Grameen Bank, developed micro-credit into an ever more important instrument in the struggle against poverty. Grameen Bank has been a source of ideas and models for the many institutions in the field of micro-credit that have sprung up around the world.
Every single individual on earth has both the potential and the right to live a decent life. Across cultures and civilizations, Yunus and Grameen Bank have shown that even the poorest of the poor can work to bring about their own development.
Micro-credit has proved to be an important liberating force in societies where women in particular have to struggle against repressive social and economic conditions. Economic growth and political democracy can not achieve their full potential unless the female half of humanity participates on an equal footing with the male.
Yunus’s long-term vision is to eliminate poverty in the world. That vision can not be realised by means of micro-credit alone. But Muhammad Yunus and Grameen Bank have shown that, in the continuing efforts to achieve it, micro-credit must play a major part.”

Fundamentals of micro finance

The managers at the MFIs are careful to ensure the borrower success and informs about the risks involved, that makes in general the borrower performing better. This leads often to earned dignity and lasting self-confidence associated with responsible loan repayment.

To have a sustainable growing economy it takes high entrepreneurship and energy in order to develop the world and fight poverty. Independet and responsible entrepreneurs are valuable resources which can take advantage of the microfinance industry. They will not take big risks and must be supported by predictable financing.

Normal bankoperations suits better to large transactions which is more profitable, the traditional operating philosophy is to invest in facilities and they have costly operating structures. The traditional financing industry must either change themselves or stay out of the microfinance business. A new generation of banking institutions is growing in a market of very small transactions and less affluent clients. With lowered transactions costs through institutional specialization and innovation in delivery systems, they will be able to operate profitable in this market serving the poor with financial services.

The poor entrepreneurs are the future representing the population who will become successful in the nearby future. They have the same will and skills as the toughest business operators. The are economical, don’t take big risks and repay debts as scheduled to maintain possibility borrowing money in the future.

This require a totally new ground breaking banking system with scale economics. Modifying the standard system will simply not be enough, the poor people will continue stay outside their country´s economy. Building up microfinance institutions serving poor people is a relatively cost effective use of subsidies for economic development compared to other supporting strategies for welfare.

Micro finance institutions.

Poverty is the main cause of concern in improving the economic status of developing countries. A microfinance institution is an organization that offers financial services to low income populations. Almost all give loans to their members, and many offer insurance, deposit and other services.

A great scale of organizations is regarded as microfinance institutes. They are those that offer credits and other financial services to the representatives of poor strata of population (except for extremely poor strata).

Microfinance is increasingly being considered as one of the most effective tools of reducing poverty. Microfinance has a significant role in bridging the gap between the formal financial institutions and the rural poor. The Micro Finance Institutions (MFIs) accesses financial resources from the Banks and other mainstream Financial Institutions and provide financial and support services to the poor.

MFIs are the pivotal overseas organizations in each country that make individual microcredit loans directly to villagers, microentrepreneurs, impoverished women and poor families. An overseas MFI is like a small bank with the same challenges and capital needs confronting any expanding small venture but with the added responsibility of serving economically-marginalized populations. Many MFIs are creditworthy and well-run with proven records of success, many are operationally self-sufficient.

Various types of institutions offer microfinance: credit unions, commercial banks, NGOs (Non-governmental Organizations), cooperatives, and sectors of government banks. The emergence of “for-profit” MFIs is growing. In India , these ‘for-profit’ MFIs are referred to as Non-Banking Financial Companies (NBFC). NGOs mainly work in remote rural areas thereby providing financial services to the persons with no access to banking services.

The term “transformation,” or commercialization, of a microfinance institution (MFI) refers to a change in legal status from an unregulated nonprofit or non-governmental organization (NGO) into a regulated, for-profit institution. Regulated, transformed organizations differ from nonprofits in that they are held to performance and capital adequacy standards and are supervised by a financial authority, typically the central bank of the country where they are registered. A transformed MFI also attracts equity investors. The equity investors want to ensure that the values of their investments are maintained or enhanced and elect Board members who share a common vision for the new for-profit institution. Among transformed MFIs, varying classifications of regulated institutions exist, the strictest being banks — rural banks and thrift banks — followed by non-bank financial institutions. Different countries have varied names for these regulated MFIs.

The microfinance sector consistently focuses on understanding the needs of the poor and on devising better ways of delivering services in line with their requirements, developing the most efficient and effective mechanisms to deliver finance to the poor. Continuous efforts towards automation of operations is steady improving in efficiency. The automated systems have also helped accelerate the growth rate of the microfinance sector.

The goal for MFIs should be:

• To improve the quality of life of the poor by providing access to financial and support services;

• To be a viable financial institution developing sustainable communities;

• To mobilize resources in order to provide financial and support services to the poor, particularly women, for viable productive income generation enterprises enabling them to reduce their poverty;

• Learn and evaluate what helps people to move out of poverty faster;

• To create opportunities for selfemployment for the underprivileged;

• To train rural poor in simple skills and enable them to utilize the available resources and contribute to employment and income generation in rural areas.

Many institutions practice microfinance, or raise funds for microfinance, including the following:

Accion InternationalACDI/VOCABRACEnterprise Development InternationalFive Talents InternationalFreedom from HungerGrameen FoundationKivaMicrofinance in UzbekistanMicroloan FoundationMicrocredit Summit CampaignMicroenterprise Access to Banking ServicesOmidyar-Tufts Microfinance FundOpportunity International AustraliaShoreBankTameer Microfinance Bank LtdUnitusWorld Council of Credit UnionsXacBankSKS