6 Things to Know About Microfinancing in Developing Nations  

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SEATTLE — The need for innovative provisional financial service is here, especially since 2.7 billion people are still living on less than two dollars a day. Microfinancing is a banking service that allows impoverished individuals to borrow money in developing nations, and often serves as a popular alternative approach to remedying extreme poverty around the globe.

Modern microfinancing began in the 1950s and has since evolved into a web of multi-lateral financial institutions comprising a sixty-billion-dollar market of which $450 million is remittance. There are roughly 1,500 microfinance institutions (MFIs) around the world and over 200 million borrowers; non-profits, credit unions, co-operatives and commercial banks are each likely to offer microfinance services.

As with numerous well-meaning aid programs, there are both benefits and drawbacks of the institution. Here’s the 6 things you should know about microfinancing.

Benefits of MFIs: 

1. Full Range Financial Services
Microlending, microinsurance and microsavings — lending, insurance and saving programs are all services offered by MFIs. “[MFIs are] meant to provide a full range of financial services to help low-income individuals meet their household needs to generate income, build assets and manage risks,” says Clara Lipson, a member of the Board of the Microfinance Club in New York.

Learning how to build assets, prepare for emergencies and risk management are all built into the MFI ideals. Kenneth Warwick of Finance & Development explains that “one of the most important requirements for an improvement in the medium-term growth performance of the indebted developing countries is a recovery in domestic saving and investment rates.”

2. Money Retention in Communities
Many of these microloans are dedicated to start-up local businesses. When major businesses are local, money is retained, used within the community and helps to support other local enterprises. “Income generated by a micro-entrepreneur can be used to purchase goods and services in the community thus leading to an improved business climate,” says Lipson. The board member also mentions an improved educational climate as community members are enabled to invest more money in resources for their children, thereby enhancing the overall scholarship of the community.

3. Financial Inclusion
Microfinancing in developing nations was created to fill the gap in banking services for financially excluded groups. MFIs were designed to stabilize and strengthen the bottom of the economic pyramid. A study from the Journal of Financial Inclusion in Asia found that microcredit interest rates were 30 percent lower than traditional moneylender institutions in Bangladesh, Bolivia, India and Indonesia.

“Microfinance served as a means for financial inclusion because regular banks tended not to lend to the poor,” co-author Rajesh Chakrabarti of Financial Inclusion in Asia says of microfinancing in rural India. The same study revealed that microfinancing provided households with more choices in the way that they invested, made, consumed and managed risks.

Drawbacks of MFIs

4. Debt & Mental Health
Microdebt is also in the lexicon of MFIs, and microfinancing in developing nations took a turn for the worst in 2010 and 2011. MFIs were blamed for many of the suicides following the recession with predatory lending practices acting as the accused offenders.

Despite opposing claims, average interest rates have been reported to be as high as 30 percent annually. This represents an unforgivable fraction of the population, and applies to members such as Rama — a woman from southern India who lives on less than one dollar a day. Rama told National Public Radio she was harassed by collectors suggesting suicide. A suggestion which Rama’s daughter took seriously, taking her own life in hopes of alleviating the debt.

5. No Reported Substantial Effects
A meta-study administered by Abdul Latif Jameel Poverty Action Lab suggested that access to microcredit did not, in general, benefit women’s empowerment, investment in children’s education, or lead to a substantial increase in income.

Many of those living in extreme poverty aren’t reached by aid. Professor of Economics at Yale Dean Karlan explains that many MFIs are unwilling to scale back loan sizes. “We also see unwillingness among borrowers to even participate …The poorest people are individuals that don’t have an activity that would even count as a microenterprise,” says Karlan.

6. Lack of Knowledge and Little Preparation
“It turns out that microfinance usually ends up making poverty worse,” Dr. Jason Hickle an anthropologist at the London School of Economics says. Microfinancing loans are typically used for consumption, and some even take loans out to pay off their other loans, picking up tandem debt along the way.

According to some experts, many borrowers don’t have a plan as to how they’re going to make the money back and they aren’t held accountable for such a proposal.  The trend of unpreparedness is what led Dr. Anurag Priyadarshee and Dr. Asad K. Ghalib to describe the microfinance industry in India as “a poster child of exploitation of the vulnerable.”

The Future of Microfinance

Some argue that microfinancing in developing nations is a movement toward financial inclusion, others claim the  movement is untenable and further cause distress and debt. While still others say it does nothing at all. With MFI practices mushrooming, the full reality of microfinancing is sure to reveal itself soon.

– Sloan Bousselaire
Photo: Flickr

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Sloan Bousselaire

Sloan lives in Denver, CO. Her academic interests include civil liberties, social justice and education policy.

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