What is a microfinance institution?
Microfinance institutions (MRIs) are financial institutions that foster the financial inclusion of those who face multiple barriers to access conventional financial institutions like poor households and small enterprises. The most prominent activity is providing loans to the
clientele mentioned above. Apart from this, many MFIs take deposits which proves to be mutually beneficial - providing saving facilities to their clients helps to smooth consumption and establishes a financial record through making and receiving payments. This record can be referred to later to determine the reliability of the borrower. In an attempt to make the credit more valuable to the borrower, MFIs also serve as vehicles to provide training in areas like business management; thereby increasing the chances of repayment.
A typical MFI clientele might be located in a remote area, possess few negotiable assets, and reside in a territory wherein enforcement of formal property rights and other contracts is uncertain and expensive. Overcoming these barriers requires innovative solutions, such as incentivising repayment. On establishing a satisfactory repayment history, the borrower can progressively obtain larger loans. The added threat to stop providing credit when loans are not repaid further increases the possibility of repayment.
The risks associated with establishing a microfinance business are high. On one hand, lending to the poor is a gamble as they cannot provide collateral, are hyper-exposed to exogenous shocks, and often have their loans intrinsically tied to their personal finances. On the other hand, the labor-intensive nature of MFIs translates into high costs of conducting business. This includes overhead costs like keeping offices open and loan monitoring. These factors compel them to charge high interest rates. Borrowers readily consent to these high rates as the alternative is acquiring loans from a moneylender at an even higher interest rate, or no borrowing at all. Thus, MFIs may have to establish a local monopoly to break even, but still have a welfare-enhancing effect.
Importance in developing countries
In most developing countries, social and economic dualism exists in the markets which manifests as a credit gap for poor entrepreneurs. This is where specialized institutions MFIs step in to include the excluded in financial institutions. More than 90-percent of our workforce is engaged in the unpredictable, dynamic informal sector. Institutions like MFIs have the ability to equip the masses with the financial knowledge required to uplift them into the formal economy.
Firstly, services offered by the institution helps their clients shift from aid-dependence to financial autonomy. It empowers them in a manner that initiatives like direct cash transfers cannot. Thus, it alleviates the powerlessness associated with poverty. Secondly, MFIs have an informational advantage. Their local proximity allows them to choose the right clients and ensure that loans are allocated accordingly. It offsets the costs of asymmetric information relatively better than direct assistance. For instance, an MFI in Indonesia relies on village heads to head a commission that allocates, monitors and enforces loan contracts. The commission consists of local agents who have access to information about borrowers. Known as the Unit Desa System, it has now become a profitable venture. Lastly, mobilizing savings of disadvantaged groups can help an MFI leverage support to increase the resources provided to them!
Case Study of Annapurna Parriwar Program
The impact of MFIs in developing countries can be illustrated through a case study on the Annapurna Parriwar Program that functions in Mumbai.
Established in 1975, it was pioneered by six local NGOs with the aim of empowering women in urban areas. It functions on a ‘joint liability group’ (JLG) model wherein members of a similar class form a group to obtain loans, ranging from INR 1,000 to INR 35,000, without providing collateral. The amount of the loan that can be availed increases as a satisfactory repayment history is established, business development occurs and an overall positive group aptitude is exhibited. It is recommended that the group save 20-percent of their earnings to be able to repay the loan.
This model has impacted the women and their community positively. For instance, over two-thirds of 718 districts in India face extreme water depletion. Women used the loan amount to improve sanitation with special emphasis being placed on clean, drinking water. Moreover, the Annapurna Parriwar loan package includes health insurance, enhancing health service access and reducing its need. Thus, the role of MFIs extends beyond entrepreneurial aid to household financial assistance.
The remaining funds are then used to fulfill personal aspirations like business ventures or saving for a new home. The NGOs provide assistance by imparting financial education on strategic spending, saving and investing. Obtaining a micro-loan also elevates their social status, enabling community participation and reducing invisibility for gender equality. This rise in social status further increases the likelihood of repayment of loans.
The success of the program has been attributed to the JLG model. The group is required to meet regularly which allows them to build a bond of trust and dependence. It multiplies the social capital available to women, provides them with role models in each other, amplifies their mobility and reduces their fear of banks. Moreover, members can borrow internally for various purposes which further reduces their dependence on moneylenders.
MFIs choose to focus on women as their contribution to family welfare is understood to be relatively higher. Thus, lending to women increases the number of people that benefit, as compared to lending to men. Moreover, workers in institutions like the Grameen Bank have observed that men tend to be arrogant; they argue and sometimes scare the employees. Thus, it is considered strategic for MFIs to target women.
By embracing the diverse needs of their clientele and promoting inclusive development, MFIs act as catalysts for economic and social transformation. These institutions underscore the potential of targeted lending to create sustainable positive change, inspiring hope and resilience in their clients.
Rashmika Sharma
