Microfinance institutions (MFIs) are able to provide banking services to populations who were previously considered “unbankable” due to factors such as low transaction costs, close proximity to traditional clients, and ability to pool resources together with the view to spreading risks for the borrower and the lender (Hailu par. 1-4).
As suggested by this author, MFIs maintain low transaction costs in terms of opening bank accounts, over-the-counter transactions, loan access and loan repayment regime, thereby ensuring that the poor in rural and urban areas are included in the financial services sector. In maintaining proximity, it is known that most conventional banking institutions in the developing economies are located far away from towns and villages and the transport costs required to access them may be unaffordable for most poor people (Hailu 3). As such, MFIs have stepped in to provide the much needed financial services to people in their villages and neighborhoods.
Additionally, MFIs can provide banking services to people who were previously considered previously “unbankable” due to deployment of structural and operational platforms that depart substantially from the way business is conducted in conventional banks. For example, most MFIs use traditional networks and peer reviews that are predicated on trusting relationships of borrowing groups to determine the creditworthiness of potential borrows (Hailu 4). This implies that loans are secured through joint liability and no collateral is needed for individual borrowers to access loans apart from their membership to a particular group. When a member of a particular group fails to repay the advanced loan, other group members are collectively held responsible in line with the principle of spreading risks for the borrower and the lender.
Expanding MFI Sector & Economic Development of a Developing Country
The MFI sector plays a significant role of empowering the poor in rural and urban areas of a developing country to access a platform where they can pool their meager incomes and assist each other to grow by starting small enterprises. Available scholarship reports that, although most people in the developing economies earn less than US$ 1 a day, the evolving MFI sector has facilitated extension of credit to this group of the population and therefore contributing to the economic development of these countries (Hailu 6).
MFIs also play a significant role in spurring the economic development of a developing country as they often contribute to the formalization of the informal sector by ensuring that small enterprises are able to access cheap loans and other financial services which cannot be guaranteed by the conventional banking sector (Hailu 9). Providing such services is the right way to go in the realization of economic development, as most of the people in developing countries are employed in the informal sector and most economies in these countries are supported by proceeds from the informal sector.
Finally, it is documented that there exists minimal evidence to show that access to financial services is the silver bullet to the reduction of poverty and facilitation of economic development in developing countries. Although it is a well known fact that MFIs not only empower people economically and socially, but also allows them to better integrate into a country’s economy and proactively contribute to its economic progression, it is still not yet clear if the dynamics of access to financial services can be trusted to spur the economic development of a developing country in the absence of other variables such as opportunities, education and awareness.
Works Cited
Hailu, Degol 2008. Equitable Access to Financial Services: Is Microfinancing Sufficient?. Web.