Posted in Finance Articles, Total Reads: 2161
, Published on 29 September 2012
Micro-credit has become a significant agent of development and has rendered a pragmatic approach to the ingrained challenges of poverty. It assists poor people markedly by supplying them credit for the micro-enterprise that would be required for income generation. Many people, who are familiar with it, generally have an opinion or notion that it is a direct way out for impoverished out of poverty. But can the micro-finance institutions live up to expectations?
The concept of micro-finance seems to be very simple, but while putting this into practice, it takes lot of effort in various stages. It has got several obstacles which are to be brought into picture to show how arduous this task of financial inclusion and uplifting of unprivileged can become.
The most predominant difficulty that the MFIs face is regarding their own existence. Let scalability be aside, even sustainability has been an uphill struggle for many MFIs. There have been many MFIs which started off with a good note but had to halt their operations due affliction of costs, risk or because of functional inefficiencies.
MFIs can be broadly classified into three categories:
Mutual Benefit MFIs: State promoted Credit Cooperatives and mutually aided cooperative societies constitute this.
Profit-Motivated MFIs: These are MFIs that thrive on the margin from the lending money and by numerous ways try to make out profit. For example, SKS microfinance in India is a Profit-oriented MFI. NBFC and Banks too which along with usual banking operations promote MFIs along comes under the gamut of this type of MFIs.
Not for Profit MFIs: NGO MFIs and Non-Profit Companies are in the purview of this type of MFIs. The only motive of these MFIs is to serve poor people and these set interest margins on money they lend only the with intent of paying back loan from their funding sources with interest and covering various costs they incur during their operations.
It has been observed that issue of sustainability increases drastically as we come down in the list mentioned above i.e. Mutual Benefit MFIs are capable of continuing their operations for considerably longer period than Profit-Motivated MFIs and Not for Profit MFIs. Even Profit-Motivated MFIs are successful in reaching a good level of sustainability, and have even produced profits without government subsidies and support from donor. The problem of sustainability mainly hounds the Not for Profit MFIs and especially NGO MFI sowing to the following reason:
1. Internal Factors
Financial activities and other processes not being carried out efficaciously.
Improper Organizational Design and structure with feeble inspection and maintenance.
Inferior Administration and governance as a cause of second-rate leadership.
The costs, expenses, frauds, HR issues, physical and financial productivity issues, internal risks and other constraints are all covered under these heads.
2. External Factors
Many NGO MFIs or other kinds of Not for profit MFIs carry out their operations in areas that are uncovered or have little knowledge about. So issues of demand and supply arise as a reason of lack of understanding of requirements of clients and inability to design products that suits their needs.
Also Not for profit MFIs face severe competition from the Profit motivated MFIs. There have been cases where these MFIs make people aware of Micro-credit and when populate in that area start taking up micro-loans, some established For profit MFIs who till now have stayed away from the regions suddenly intrude into the territories of the Not for profit MFIs and snatch their share of market. As a reason many MFIs thrive to exist.
There have been credibility issues with some MFIs and because of this sources of funding that are banks and other investors are not much supportive about lending capital. They fear if these MFIs go bankrupt due to improper functioning, the debts on the MFIs would go bad. For bigger MFIs there are rating agencies which provide required grading, but smaller MFIs don’t have anything to justify that they are organised enough to pay back loans.
So if the MFIs can focus on their activities better only if their establishment is stable. Furthermore it is also a necessity for scale up their operations.
An additional problem is that while aiming for greater outreach i.e. covering maximum number of clients, the MFIs operate within a region that has greater density of people and cover the areas that are closer to their region as they can be more watchful on the clients. In process they shun the areas which are distantly located and sparsely populated which results in many necessitous remaining under serviced.
A conception is prevalent that just infusion of capital through micro-credit can alleviate the position of poor and end their poverty forever. But that is completely deviating from fact. There are several other requisites that have crucial role to play by supporting microfinance to end the cycle of destitution. Here are some problems for which solutions are to be figured out so that the indigent people feel encouraged to take the services from MFIs.
These Poor people are way away from social and economic security. They don’t have access to Proper education, housing and other essential needs. Only after they have all these basic things without which a person can’t live, they will direct their thoughts towards other purposeful activities. It is impossible for them to dare to experiment with the minimal capital and time they have.
Also these people are very much vulnerable to unforeseen crises. There may be natural calamities or sudden health problems to any member of the family. This uncertainty leads them to falling prey to further debts.
Moreover taking a look at financial facilities in rural areas, it is found that not only there is lack of credit, but also other financial services are unavailable. There are no banks, not even rural ones in many remote areas.
Poor have much inclination towards loans than savings, because of which they run into problems of accumulated debts. It is psychological phenomenon that is prevalent in most of the poor people. Besides that they ignore the interest rate while taking loans from different sources and see only one thing that, whether are they easily getting the money or not. Moneylenders trap these innocent chaps only because of this lack of knowledge and understanding.
What is more is that there has been failure in understanding the pattern of credit needs and credit availability by MFIs. Most of the poor people can go for opening small businesses only after their basic needs is satisfied up to a certain level. So they would go for satisfying their consumption needs first from the money they borrow from different lenders. They would purchase items for household needs, send their children to schools and look at medical demands. Only after they are content with lower needs, a thought of going for higher alternatives come into mind. So, only after they get their basic things right, they will focus on their production and productivity needs i.e. income generation sources, where they see effectivisation (boosting their income generation activity) and enhancement methods. Later aspiration for diversification arises and they move to different avenues in search of better income that would lead to better life.
A popular study finds about handling of loans by poor people and some interesting revelations have come out from that. It shows that only 25 % of the loan issued was used for income generation purposes where as a whopping 59 % was consumed for household purposes. This indicates a huge gap in utilization of funds from MFIs. It also emphasizes the need of invigilation on clients by these finance institutions.
Microfinance is relatively a very new field in the area of finance and developmental research work are going on delve deeper into the concept. Also there are very limited insights available about Bottom of pyramid segment of people which leaves a lacuna in the knowledge domain. As the industry is getting more and more mature, many aspects are being uncovered. Micro-credit is much more complicated than supposition and needs foresightedness to gauge the deep rooted challenges associated and their solutions.
This article has been authored by Indrajit Bage from IIM Shillong.
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