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Socioeconomic Impact of Micro-Credit Financing Research Paper

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Updated: Jun 5th, 2020

Microcredit is kind of loaning that instigated in Bangladesh in the fiscal 1970s. The process entailed giving out loans to micro-enterprises or small businesses with the objective of assuaging the skyrocketing levels of poverty. In fact, the micro-loans were issued by the Microfinance Institutions that had very high interest rates that were intended to cover the allied high outlays of giving such micro-credits (Pitt & Khandker 1998, p.960). Since the micro-credit was purposely a mechanism to relieve poverty, people who lacked steady employment and those who had low credit scores were able to receive these micro-loans which acted as their capital to start and advance their respective business enterprises.

Microfinance pains and gains

For many years, announcements by organizations that they extend their commitment to microfinance investing substantial amounts of funds have been indications that institutions now take the strategy seriously. Microfinance investment has the capacity to give the fund with a combination of solid growth and attractive returns, relatively different from equity markets in developed economies. Nonetheless, many efforts of individuals in microfinance institutions show a sector on edge with its new position as asset class for global investors. Indeed, many are troubled by the new language of microfinance including ‘return on equity’: if an institution is making profits, it is moving into the same mental mindset as loan sharks. The microfinance sector is worried whether both profit and non profit frameworks can coexist. Despite many reservations made by the institutions, the important point is to get institutional capital into third world nations where there is not enough of it. What is apparent is that international investors are increasingly supporting microfinance and the sector is growing rapidly (Wheelan, 2008, p.2).

Competition among microfinance organization is more evident than ever which adds to the gains of the parties on the receiving end. Many of them are now running asset worth billions of dollars, all incorporating overlay. Indeed, running specialty funds like microfinance in the highly competitive area of asset management creates a distinctive brand to some organizations. However, the goal is not financially related: the question is how the social return is managed. Looking at microfinance competition in various countries, one can see the potential problems. The initial public offering by some of the organizations raises overwhelming amounts of funds, but outrages campaigners when it is revealed that such funding institutions charges even up to 70% interests on their loans.

Microfinance contributes to diversification of an investment portfolio. Essentially, larger microfinance projects have even bigger social consequences. It is predicted that the next development in the sector is more consolidation. Institutions will merge and commercial banks will be seeking to be involved. There could also be a move from the traditional group lending to individual lending. The growth of institutions has led to examinations related initiatives such as innovative suit of loan products in the fields of agriculture, food, water and land in developing countries. They are now working with pension funds in these countries and have found the appropriate projects. Institutions are getting economies across what they do because they are in the microfinance sector, meaning that they are constantly looking at various countries and currencies while creating alliances on the ground.

Bangladesh Microcredit

The development of Bangladesh microcredit occurred in a number of distinct stages over the last two decades. The current microfinance model originated from the action-research in the 70s to cope with the rehabilitation and relief needs of post-independence (CDF, 2006). The microcredit was first started by Grameen Bank through a team led by Mohammad Yunus. The model was tested first focusing on group-based credit offering with peer monitoring. As this model developed, others were started by the Bangladesh Bank while collaborating with Swanirvar Bangladesh as well as other pilot projects begun by a number of NGOs.

More microfinance institutions experimented with varying modalities of giving credits to the poor in the 80s. NGOs experimented with varying approaches of delivering credit in early 80s. A significant model experimented was the efficacy of giving loans to groups compared to giving loans to individuals associated with peer monitoring. The individual approach emerged to be more effective because of incentives and ‘joy-rider’ problems compared with group credit. Hence the model that dominated was that of giving loans to individuals in an effort to target clusters of poor families, with peer monitoring and solid microfinance staff follow-up.

The girl effect, Kiva

Kiva is the first person-to-person website in the globe that focuses on empowering people to lend money directly to distinct entrepreneurs around the world for the sake of lessening poverty. With its origins in the work of Nike Foundation, the girl effect has been combined by NoVo Foundation in a common undertaking to create economic opportunities for girls. Through the initiative, adolescent girls are distinctively able to raise the standards of living in third world countries. Through Kiva, other organizations are able to locate the girls in need especially in countries where information technology has penetrated. They are able to communicate their help initiatives through the websites which alleviates the difficulty of accessing institutional help by the girls in developing countries. The website is also a channel of giving loans by the microfinance institutions (Berthelemy & Varoudakis, 1996). In fact, the major aim of creating a global website was to develop a platform through which microfinance institutions could help the girl child in developing nations.

Contribution to the countries’ economy

There is a link between the development of microfinance and economic growth of a country. Researches indicate that microfinance contributes to increased investments and growth of capital. Moreover, microfinance builds on financial services that are needed to make investments in physical and human capital, to smooth consumption as well as to overcome unexpected shocks. It has been perceived as a solution on large scale previously excluded poorer groups without access to capital from the conventional financial system (Banco Sol, 2006, p.7).

The financial sector in developing countries is characterized by dual financial systems which are formal and informal. Majority of the low income people are left out in both the sectors especially the informal sector that purports to cater for the low-income and poor in society (Pagano 1993, p.618). The access to the formal sector is primarily due to the lack of collateral that is needed because of risks involved in lending as well as high costs involved in small-scale financing services and weak legal enforcement (Ray 1998, p.214). Therefore, the low incomers find themselves being served by the informal financial intermediaries that possess informational advantage over formal financial intermediaries on these clients.

However, the informal financial intermediaries have insufficient savings facilities coupled with limited funds. Moreover, they incur higher costs in lending for their clients compared with the formal sector. Because of these pitfalls of both informal and formal financial intermediaries, the microfinance comes in to take the informational advantage of the informal sector to increase the availability as well as improve on the financial services for the lower income level (Banco Sol 2006, p.7).

Though previous researches indicate that there is a strong correlation between economic growth and the development of the financial sector, some scholars dispute the directionality of this interrelationship. The argument is whether the economic growth contributes to the development of financial markets or whether financial systems lead to the economic growth (Bencivenga & Smith 1998, p.371). Nevertheless, it fair to make the assumptions that there exist a link between the economic growth and financial sector. At the micro-level, there is a differing effect of the financial system as a result of different institutional build up and policies. Moreover, there are imperfections in the financial markets. Poverty level and development gaps are higher in conditions where both financial systems and economic growth remain at an undesirable equilibrium (Berthemeley & Varoudakis 1996, p.310). In developing countries that normally have stagnated economic growth, there may poor development of financial markets as a result of underdeveloped or inexistent financial markets. In such conditions, microfinance comes in aid of the low income that has little access to the minimal financial services (Berthemeley & Varoudakis 1996, p. 313).

It is now apparent that there are interlinkages between the development of financial systems and economic growth. The development of microfinance is seen as a way of dealing with imperfections in the financial markets, the imperfections that contributes to the drawback of investment opportunities at the lowest levels of income. Moreover, microfinance contributes at the larger scale the income generation as well as the financial sector development (Morduch & Jonathan 2000, p.623). That is, microfinance contributes to the macro-level growth by targeting small scale and micro-level enterprises.

International treaties

The growth of microfinance in the developing countries have led to the need to have a regulatory framework that can be used as a control measure in the behavior of these small scale financial enterprises (Bencivenga & Smith 1998, p. 366). Another important factor is the development of markets. In comparing the performance of microfinance in various regimes and regulatory frameworks that support its development is far much different. Furthermore, there is a big difference regarding the institutions that are serving the poor household and small scale entrepreneurs in various developing countries (Pagano 1993, p.615).

Taking these variations into consideration and taking cognizance of the importance of microfinance in the development of the economy, different developing countries have come together to harmonize the regulatory framework as well as expanding the market for the development of the microfinance (Morduch & Jonathan 2000, p.627). Various international development institutions such as World Bank and United Nations have also contributed hugely in the harmonization of the regulatory framework and have worked closely with many countries in the development of microfinance.

Successful stories about microcredit

Globally, real people have over a period of time given their success stories as regards to microcredit. These are as explained below.

Sri Lanka

Alice Pallewela had to turn to her credit union and candy when she really wanted finance for supporting her family (“Microcredit Borrower Stories” 2001). The doubtful blend significantly changed the perception of the village with respect to the credit unions and her life was not left unchanged too. Alice and her husband moved to Yodagama, an agricultural colony scheme after their marriage. However, not everybody was deemed a farmer given that other populates were micro-entrepreneurs while others artisans. There, Pallewella knew she had to commence a personal business that could supplement the remuneration the husband got from his employment. Subsequent to making a decision to do business, she had to select the kind of business she wanted. She made a very easy choice of being a candy (Swider, n.d).

She loved sweets and enjoyed the customary sweet preparations that were carried out in the celebratory periods. What inspired her most was the fact that a candy seller who was very close was approximately fifty miles away and this attested to be the correct niche. She collected data for six months and thereafter opted to vend just a few candies which were made via the accessible local raw materials. However, after six months, she really wanted to buy additional equipment and she was granted a loan of $100 that she requested from her credit union. The credit union besides offered Pallewela the necessary credit plus technical advice she wanted to build on her candy business (“Microcredit Borrower Stories” 2001). At the moment, Pallewela has enough profits from her business which she can regularly save (Swider, n.d). This has actually offered an opportunity for the credit union to provide micro-loans to several other micro-entrepreneurs.

The republic of Dominican

Damian Altagracia initiated a small ceramic business in the republic of Dominican. In 1987 when she instituted her business, she merely possessed sixteen cents. After operating for just a couple years, Altagracia requested a loan from the ADEMI. This micro-finance lending institution offered her $80 that Altagracia used in purchasing glazes and clay (“Microcredit Borrower Stories” 2001). From the time she received the first micro-loan from ADEMI, Altagracia has opted from more eight micro-loans from the same micro-finance institution. Even though Altagracia does not have fixed remuneration package, she has managed to employ seven workers who assist her in carrying out the business. Altagracia sincerely gives appreciations to ADEMI for the support she was given which helped her to manage the advancing business (Swider, n.d). She has climbed out of the life-threatening poverty and can now manage to pay the school fees for her kids’ schooling.

The social and cultural impact of micro-credits

The social and cultural impacts of micro-credits are hard to gauge. In fact, practitioners have viewed the practical impacts of micro-loans finance intervention from just the economic and social perspective. However, in the developing countries like Bangladesh and Kenya, the micro-loan movements have alleviated poverty. These two countries are historically poor but have the long standing micro-credit lending history (Pitt & Khandker 1998, p.961). Irrespective of this, most communities have increased their social ties which accrued as a result of the micro-credit finance. Individuals through forming groups that are used by micro-finance institutions to give out micro-loans have come to know and appreciate each other. In this regard, micro-loans have critically reduced the levels of poverty that initially existed in various societies.

However, the supply of micro-loans should not be short run but instead is ought to be long run to increase the capacity of households to permanently create wealth and alleviate poverty (Morduch 1999, p.1571). Given that micro-loans are based on the belief that the underprivileged are eager to pay higher rates of interest to get the micro-loans, the system is anchored on a collateralised social trust. Members in the small groups are the pioneers. Each individual within group gets a loan yet the whole group is held accountable for the micro-loans repayment. Thus, borrowers who fail to accomplish the loan repayment commitment are bound to lose their cultural and social ties and capital.

What might happens when micro-loans are stopped

In the event that micro-loans are stopped, the poor people in the developing world will not be able to effectively run or manage their businesses. Those who lack capital might continue languishing in poverty (Credit and Development Forum 2006). The rate of unemployment will also rise since micro-loans have enabled individuals to be self-employed. Therefore, the rate of growth and development in developing world might decrease if micro-loans are stopped.

Microfinance and financial aid

In as much as the development of microfinance contributes hugely to the development of developing countries’ economies, financial aid still forms the backbone through which these enterprises could develop (Pagano 1993, p.620). In other words, aid can be used to develop the micro finance enterprises. In the perspective of helping the poor, the development of microfinance will provide a permanent solution. However, developing countries must develop their financial systems that incorporate the needs of the low-income. In essence, microfinance should be developed to help the poor household instead of depending on the financial aid that is even more costly to the countries’ economy (Ray 1998, p.367).

References

Banco Sol, S.A. (2006). BancoSol: From Microcredit to Microfinance. Web.

Bencivenga, V. & Smith, B. (1998). Economic development and financial depth in a model with costly financial intermediation. Research in Economics, 52(4), 363-386.

Berthelemy, J. & Varoudakis, A. (1996). Economic growth, convergence clubs, and the role of financial development. Oxford Economic Papers, 48(2), 300-328.

Credit and Development Forum (2006). Bangladesh microfinance country profile. Web.

Microcredit Borrower Stories. (2001). Campaign News. Web.

Morduch, G. & Jonathan, M. (2000). The microfinance schism. World Development, 28(4), 617-629.

Morduch, J. (1999). The microfinance promise. Journal of Economic Literature, 37(4), 1569-1614.

Pagano, M. (1993). Financial markets and growth: An overview. European Economic Review, 37(2-3), 613-622.

Pitt, M. & Khandker, S. (1998). The impact of group-based credit programmes on poor households in Bangladesh: Does the gender of participants matter? Journal of Political Economy, 106 (5), 958-996.

Ray, D. (1998). Development economics. Princeton: Princeton University Press.

Swider, P. (n.d). . Web.

Wheelan, H. (2008, September 2). SNS asset management: the growing pains and gins of microfinance. Responsible Investor. Web.

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