Wednesday, December 31, 2008

Basics of Microfinance

What is microfinance?

Microfinance began as a financial system to provide poor families with very small loans (micro-credit) to help members sustain income-generating activities. Micro-credit came to fore-front in the 1970s, through the efforts of Mohammad Yunus, a microfinance pioneer and founder of the Grameen Bank of Bangladesh.
The definition of microfinance has since broadened, and includes savings, insurance, and money transfer vehicles; the industry has realized that those who do not have access to traditional formal financial institutions actually require and desire a variety of financial products.
Micro-credit has largely been directed by the non-profit sector, but recently we see, the emergence of “for-profit” MFIs. In India, these ‘for-profit’ MFIs are referred to as Non-Banking Financial Companies (NBFCs).

What is a Microfinance Institution (MFI)?

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. Various types of institutions offer microfinance: NBFCs, NGOs, cooperatives, private commercial banks and sectors of government banks.
Some NGOs offer micro-credit as one slice amongst a host of non-financial development activities. MFIs opted instead to focus solely on microfinance, to develop the most efficient and effective mechanisms to deliver finance strength to the poor.
How does microfinance help the poor?

Microfinance plays an important role in fighting the multi-dimensional aspects of poverty. Microfinance increases household income, which leads to attendant benefits: 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, especially women, to become economic agents of change - they increase income, become business-owners and reduce their vulnerability to external dependence.

When is microfinance not an appropriate tool?

Micro-credit is best-suited to those with entrepreneurial capability and opportunity. This translates to those poor who work in growing economies, and who can undertake activities that generate weekly stable incomes. Microfinance is inclusive of a much larger range of clients.
However, many poor do not fit within the current structure of microfinance. One reason for this is extremely poor people (destitute and homeless) lack a stable income. Without a stable income, it is difficult to make the weekly repayments that micro-credit requires. Credit requires a 98% “hit” rate to be successful, as high default rates undermine the very principles of lending.
Why do MFIs charge such high interest rates to poor people?

Micro Finance Industry is different in the sense, it meets the Customer in the Door step itself and serve them. The Training, on-site collection and weekly meetings are all cost to the Micro Finance institutions which adds up to the operations cost. Banks charge anywhere from 12 to 13.50 % interest and with this direct service costs to companies, Micro Finance institutions are forced to charge from 20 to 25 % to customers.

How do you know microfinance is making an impact?

Microfinance has gained popularity for several reasons. One, it is a much better alternative than the informal financial sector. In India for example, moneylenders charge rates of 36-72%. Secondly, members realize the value of assured long-term access to credit.
This access to finance allows women to increase income, which benefits the entire household. How do we know this? Our return on investment (ROI) calculations demonstrate that most borrowers earn anywhere from 25%-200% more than the interest rate charged, due to low infrastructure costs, no tax or legal costs, and the overall capital cost that is just a small percentage of the total cost.

Why doesn’t NBFC based MFI allow members to save?

Majority of the MFI being a Category “B” registered NBFC, RBI does not allow Category “B” companies to invite Deposits.

Why do you only lend to women?

Social development studies have demonstrated that women are much more likely to reinvest income into the household, for the benefit of the entire family.
Can microfinance be profitable?

Yes it can, as the report demonstrates.

Data from the Micro-Banking Bulletin reports that 63 of the world's top MFIs had an average rate of return, after adjusting for inflation and after taking out subsidies programs might have received, of about 2.5% of total assets. This lends to the hope that microfinance can be sufficiently attractive for investors, as well as the mainstream into the retail banking sector.

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