By Deanna Morris
Over the past few decades, investment in microfinance has increased because from a business perspective it has been seen to be an extremely lucrative industry due to what the Global Researcher recently called “extraordinary returns on investment”.
However, opponents of the microfinance industry, particularly those who are critical of companies entering the industry as a for‐profit business investment rather than those microfinance institutions (MFIs) interested in poverty reduction, are questioning the practices and sustainability of the microfinance industry.In the face of a crumbling reputation of the industry, this article is an attempt to highlight some of the issues involved and point to possible solutions that can help it regain trust and respect from borrowers, and its critics, as it continues to expand and attract investors at a staggering pace.
- One of the biggest critiques of the industry is lenders’ extremely high interest rates, which often are presented in a deceivingly positive light…another problem is the questionable tactics, such as intimidation and public humiliation, used to recover debt from participants.
- Although there are deficit areas, organizations with strong education and training programs, as well as reasonable interest rates, will continue to be successful in achieving the overall goal of poverty reduction.
What exactly are the problems with Microfinance?
One of the biggest critiques of the industry is lenders’ extremely high interest rates, which often are presented in a deceivingly positive light, when in fact interest rates are incredibly high and can leave borrowers heavily indebted. It has been argued that “…as more capital and competition enter this market, interest rates will likely come down and more impoverished borrowers can be reached” (Global Researcher, p.81). However, when one looks back historically this has not necessarily been the case. Microlending programs have been around for 25+ years and as new players have entered the market creating even more competition, interest rates still remain high, which begs the question: is increased competition spurring greed and encouraging investment in microfinance for the wrong reasons?
The lack of transparency over interest rate payments has left many borrowers more indebted than they had understood. This is further compounded when the borrower education and training component of micro‐lending (which is vital and takes centerstage in poverty‐reduction centered micro‐credit programs) is inadequate or missing since it does not represent a direct return on investment for profit‐motivated institutions.
See also:
- Can There Be a Workable Microfinance?
- A female entrepreneur transforming lives of thousands in Tanzania
Another problem is the questionable tactics, such as intimidation and public humiliation, used to recover debt from participants. This results in borrowers taking out even more money from local money lenders, whose interests rates are often considerably higher than those of MFIs, to pay back initial loans; thus putting the borrowers into even more debt, which runs opposite to microfinance’s overall stated goal of poverty reduction. As more micro‐lenders are entering the market, allowing people to take out even more loans,fears are rising concerning the integrity of the industry and that this cycle of indebtedness is being continued, rather than mitigated.
Finally, industry ethics and are further questioned when a MFI begins its business practices as a not‐for‐profit, in which it may be benefiting from international aid funds, only to later change itself into a for profit organization, that goes public on the stock exchange and makes only a few people (i.e. its largest share holders) extremely rich. Examples of this can be seen in both India and Mexico, with the organizations such as SKS and Compartamos Banco.
So what can be done to improve microfinance?
As the microfinance industry grows in the coming years it is necessary to have regulations or regulating bodies put in place to ensure for transparency, prevent interest rate gouging, and protect citizens from becoming over indebted.
As the microfinance industry grows in the coming years it is necessary to have regulations or regulating bodies put in place to ensure for transparency, prevent interest rate gouging, and protect citizens from becoming over indebted. This is not to say that the industry should be so heavily policed that it eventually becomes strangled, but that minimum standards should apply to ensure a level of responsibility and best practice. To do this many look to interest rate caps as the solution, however creating a cap on the amount of interest charged actually works to make the microfinance market unviable.
Interest rates are needed to cover lending risks, inflation, the cost of capital, etc, all of which can fluctuate depending on the MFI. Caps can also drive borrowers to more flexible means of financial service such as that offered by local money‐lenders or loan sharks whose higher interest rates can leave borrowers worse off. Thus other solutions must be realized. One example can be found in Peru, which is known for “having the best business environment for microfinance, in part because the regulator has successfully set and enforce rules on capital buffers, leading to a more stable” lending industry (The Economist, 2010). Implementation of MFI accountability and regulation standards such as this will be helpful in creating an industry structure that is reliable and less prone to gouging the poor with high interest rates, forcing them into a cycle of debt, and/or being subjected to harsh repayment enforcement.
However, aside from the critique of MFIs, one of the positives results of micro‐lending is that it is also helping the poor build savings, particularly through initiatives such as Oxfam’s Saving for Change program. Savings for Change (SfC) is considered to be a form of savings‐led microfinance; this specific program typically focuses on women and is horizontal in structure. The initiative allows groups to save, lend, gain interest on their savings through lending within the group and determine these interest rates as a group, by working together in the overall creation of the program. A key component of SfC is training; a variety of tools to train groups are used, particularly through visual and oral training methods to compensate for illiteracy.
Therefore, programs which focus on savings are much more helpful than microcredit, which just issues small loans to tide people over during emergencies. In addition, savings initiatives can also fill the microcredit finance gap, which currently stands at around $US 260 billion1, since savers would borrow from their group’s own invested capital, allowing them to set their own interest rates rather than depend on international investment and high interest lenders.
In summary increased regulations, such as the example presented of Peru, and new initiatives such as programs like Saving for Change may not be a panacea however initiatives such as these can work to alleviate some of the issues discussed, such as high interest rates, forceful debt recovery practices and companies entering the market for the wrong reason. Overall there are definitely some struggles and shortfalls faced in the microfinance industry. Although there are deficit areas, organizations with strong education and training programs, as well as reasonable interest rates, will continue to be successful in achieving the overall goal of poverty reduction. However as more companies, particularly those with profit making objectives, enter the market the necessary steps must be taken to prevent incredibly high interest rates and practices that force the poor into a cycle of indebtedness.
Works Cited
Global Researcher. (2010). “Evaluating Microfinance: Do Small Loans for Poor Entrepreneurs Help End Poverty?” Global Researcher, 4, 81‐103. Retrieved from www.globalresearcher.com The Economist. (2010, November 18).
“Leave well alone.” The Economist Print Edition. Retrieved on December 15, 2010
From http://www.economist.com/nod e/17522606?story_id=17522606 &CFID=156780073&CFTOKEN=2 6992579
(Deanna contributed this post as a GSDM Special Correspondent and it was first published in GSDM’s Jan 2011 edition Myths of Microfinance)
Read another article by Deanna Morris: Cambodia: Inclusive Education Combats Social Barriers
